No glossy reports? “We never hold this against them’’

Responsible investment is not limited to large companies. Although most Small Cap strategies are not explicitly Responsible, ESG considerations play a prominent role here.
Mei 2020

Catherine Stanley

Managing Director, Head of Global Small Cap, Global Small Cap

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Risk Disclaimer 

The value of investments and any income from them can go down as well as up and investors may not get back the original amount invested.

Investments in smaller companies carry a higher degree of risk as their shares may be less liquid and investment values can be volatile.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Responsible investment is not limited to large companies. Although most Small Cap strategies are not explicitly Responsible, ESG considerations play a prominent role here. But they do so in their own way. “There is an overlap between ESG risk and investment risk.” We put forward five questions on this subject to Catherine Stanley, manager of the BMO Global Smaller Companies Equity strategy and to Irina Hunter, manager of the BMO LGM Global Emerging Markets Smaller Companies strategy.

Risk Disclaimer 

The value of investments and any income from them can go down as well as up and investors may not get back the original amount invested.

1.How do smaller cap companies fare in adapting ESG-requirements compared to large cap companies?

“Looks can be deceiving”, says Catherine Stanley: “Some smaller companies can appear to look worse on ESG, because their disclosure of ESG-related aspects can be poor and smaller companies have less resources in general for sophisticated disclosure. This does not necessarily mean that they have not thought about ESG. Often you need to ask them to find out where they are. You cannot apply the same bar to large and small caps.”

Irina Hunter agrees: “If we ask for too much detail and reporting from our small companies regarding their ESG credentials, we may not get a good answer. Discussing the company culture and principles on which the business is run is often better when meeting with management teams at small companies; how they allocate capital, how they treat both minority shareholders and their employees as well as other stakeholders. This is not market cap specific. Then it becomes clearer which businesses we want to invest in for the long term.”

 

2.Also, Smaller Caps are covered less by ESG research houses such as MSCI and Sustainalytics. If disclosure is patchy, can you as portfolio manager, access enough ESG data on companies?

A no brainer for Irina Hunter: “You need to talk to your portfolio companies regularly and ask the right questions. Not all small cap companies produce glossy sustainability reports. But we never hold this against them. Again, for us it is more important that the business we invest in is run responsibly and if they are treating water, electricity and other resources responsibly. Transparency is a sign of a well-run business and this doesn’t depend on market cap.”

“This is also where the BMO Responsible Investment team comes in’’, says Stanley. “For us, talking and keeping in close contact with the companies we invest in is the most important way of obtaining information. But we also receive input from our Responsible Investment team, whose 19 members form an integral and essential part of the wider BMO GAM organization and have extensive experience in conducting research and voting and engagement.’’

“The level of disclosure does vary in different markets”, says Irina Hunter. “Companies in China and South Korea fare much worse than businesses in India, Eastern Europe or Mexico on average. Also, it matters where a company is listed. Exchanges such as the ones in Hong Kong, Europe and the US have extensive disclosure requirements.’’

 

3.Then how do you integrate ESG in your investment decisions?

“Since we are not an explicitly Responsible strategy, we focus on those elements of ESG that may materially affect the financial performance of an investment’’, says Catherine Stanley. “We believe that a strong and improving ESG profile will support the valuation of a stock. And we think there is an overlap between ESG risk and investment risk. Poor management of the workforce for example will ultimately lead to higher churn, higher absence and higher costs. If ESG risks are indicated, we will take this into account in our assessment before we invest and decide whether they could be significant to the financial performance of the business in the future.”

Irina: “The Emerging Markets Small Cap strategy we manage is not a responsible strategy from an industry wide ESG-definition either, although our investment philosophy of long term investing in well run, high quality businesses is in-line with what the industry now considers Responsible. Our mindset is firmly set on the fact that our portfolio companies should be run responsibly with a long term view. If a company in our universe does not meet our quality criteria as far as corporate governance, prudent allocation of capital, fair treatment of minorities and their own productive resources, we just do not invest.’’

 

4.What are the effects on the small-cap category of adapting ESG-aspects?

Catherine: “Considering ESG-aspects helps companies think long term about risk and sustainability of their business model. This does involve some time and costs, but businesses that manage to do this properly, have an opportunity to stand out. An example is the American tank barge operator Kirkby, whose leadership position enables it to invest ahead of its competitors in environmentally safer and more efficient boats, allowing it, again to maintain that leadership position.”

This also applies in the EM-area. Irina: “Yes, there are several examples of small cap businesses, whose corporate governance standards and culture would rival that of their Large Cap peers. Take Amrest, for example, our operator of KFC and Pizza Hut in Eastern Europe. Their corporate culture is based on operational excellence and a sense of ownership at every level – every store manager knows how much they make in revenue and what their costs are. Their governance reflects a long-term approach to growing the business and their approach to talent is driven by encouraging initiative and promoting from within. These are the kind of small cap businesses that we focus on.”

 

5.Do you have a post-investment process to follow-up on ESG-issues and can you have an impact on smaller companies as an active owner?

Catherine: “We have a system of closely keeping track of our meetings with companies and of all issues that were discussed during the meeting. ESG-analysis is part of our ongoing assessment of a business, but this is different from engagement, since we usually do not set specific ESG-targets post-investment. However, raising ESG-issues regularly in meetings is a good way of getting ESG on the board agenda.

With the BMO Responsible Investment team, who runs an extensive engagement program that also involves small and midcap companies, we mostly work on governance issues. Last year one of their focus areas was ESG-disclosure at mid and small cap companies. Once invested in a company we use the quarterly ESG analytics reports that the RI team provides, monitoring companies for ESG related issues.”

For the Emerging Market-strategies, Responsible Investment expertise is also available through a dedicated RI-team member.  Irina: “In addition to staying very close to our companies and regularly discussing governance issues, we engage with our companies on a variety of topics such as resilience of their supply chain and sustainability of various resources such as water. The latter was a topical discussion with our South African companies a few years ago during the drought.  We also engage to improve disclosure in our companies.”

Investments in smaller companies carry a higher degree of risk as their shares may be less liquid and investment values can be volatile.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Investing in Small Cap Companies

BMO Global Asset Management gives investors access to what we believe to be the world’s very best smaller company investment opportunities. Our actively managed global and regional small and midcap strategies can provide investors with an exposure to carefully selected, high growth companies, delivering capital growth and outperformance.

Both in the developed world and in emerging markets, the smaller cap universe is one of the few places where one can have a genuine information advantage. In this way, active managers can find great businesses which are simply not yet appreciated by the market. BMO Global Asset Management offers several smaller cap investment opportunities, both local and global. We highlight three of these strategies below.

BMO GAM Global Smaller Cap Equity

Team:

The BMO Global Smaller Companies Equity strategy is managed by Catherine Stanley, Lead Fund Manager, Head of Global Small Cap. Catherine, with 28 years of experience, is supported by four alternate Fund Managers and an analyst. There is a strong team approach with all six team members fully involved in stock selection working on a sector basis.

Objective:

The objective of our strategy is to achieve long term capital growth and outperformance over a rolling 3-year period (gross of fees), delivered through investment in companies mainly between $500m and $10bn.

Benchmark:

MSCI Global Small Cap Index. Given the concentrated nature of the portfolio (70 to 90 stocks), all our holdings are highly active positions relative to the benchmark.

Our Philosophy:

Stock selection, rather than asset allocation, is the most important component in terms of maximising return potential and controlling risk. Consistent superior investment performance can be generated through the identification of quality businesses where valuation suggests scope to outperform the market over the medium to long term.

Our Process:

Our disciplined investment process allows us to take long-term views which are distinct from an increasingly short-term market place. The companies we invest in generally have sustainably high returns and strong balance sheets backed by stable cash flows and proven management teams. This leads to a concentrated, but diversified, high conviction portfolio with low turnover.

ESG:

Prudent management of ESG issues can have an important impact on the creation of long term shareholder value and improve the risk and return profile of our clients’ portfolios. Our ESG process consists of: ESG Integration, Proxy Voting and Engagement.

BMO LGM Emerging Markets Smaller Companies Strategy

Team:

The strategy is managed by a dedicated and experienced team of three, that can leverage on the broader investment team of LGM, the Emerging Markets boutique of BMO GAM, with a total of 16 portfolio managers and analysts, including one Responsible Investments analyst.

Objective:

Providing capital growth by investing in a carefully selected portfolio of smaller companies from across the emerging markets.

Benchmark:

We take a non-benchmark approach to investment, with an active share of typically around 95% against the MSCI EM Small Cap index.

Our Philosophy:

We believe that dominant, well managed businesses could become powerful investments. The undiscovered nature of small cap companies could amplify investment returns when they have support of structural multi-generational growth drivers. We are bottom-up investors with a long-term view.

 

We focus on quality companies with a:

 - Sustainable business model

 - A robust balance sheet

 - Alignment with majority shareholders

 - A proven management team

Our Process:

From a universe of over 25,000 listed companies, we come to a concentrated portfolio of typically 30 to 50 holdings through a process of Idea Generation, in-depth company analysis and disciplined investment decisions.

ESG:

ESG factors around corporate governance and sustainability are key considerations in our investment process and feed into our overall assessment of the quality of a business. These factors are extremely important to the overall sustainability of a company’s long-term franchise and cash flow generation.

BMO GAM US Small Caps

Team:

The small cap portfolios are managed by the US BMO Disciplined Equity Team, that manages USD 1.4 billion across five US small-cap portfolios. (31/03/20)

Objective:

Outperforming the benchmark by 2%–3% over a full market cycle with tracking error in the range of 3%–6%.

Benchmark:

Russell 2000 Index. The investment universe is not limited to stocks in the benchmark; the team may add other stocks with similar market cap and style characteristics.

Our Philosophy:

We believe that fundamentally strong, attractively valued companies with growing investor interest will outperform over the long run. We identify these companies and build portfolios using a systematic, datadriven process that avoids behavioral biases and grounds all investment decisions in hard data and time-tested investment principles. The team thus blends the benefits of a fundamental perspective with quantitative implementation.

Our Process:

A process that combines quantitative tools with fundamental analysis is more likely to deliver consistent long-term alpha within a risk-controlled framework. We deliver consistency and repeatability through a disciplined process, considering the investable universe, risk and return evaluation, and portfolio construction.

ESG:

The BMO Disciplined Equity Team integrates ESG drivers into its stock selection, portfolio construction and monitoring processes by using, amongst others, proprietary ESG-scores provided by the BMO Responsible Investment (RI) Team, regular collaboration with the RI team, a fundamental review of any buy/sell decision and active ownership, through the voting and engagement program of the RI team.

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