Small Cap Companies, Large Scale Innovations
The following is a transcript of the Alger Small Cap Focus Strategy Podcast.
KEVIN COLLINS:  Hello, I’m Kevin Collins, Client Portfolio Manager at Alger.  And you’re listening to The Alger Podcast.  Today, I’m speaking with Amy Zhang, Portfolio Manager for the Alger Small Cap Focus strategy.  At Alger, we believe focus strategies are appealing because they allow portfolio managers to allocate assets to their highest conviction positions. In this podcast, Amy discusses her differentiated approach to managing her strategy and why we believe this is an attractive time for investing in small-cap companies benefiting from large-scale innovations.

Amy, you’ve been managing small cap focus portfolios for 15 years and recently reached your three-year milestone as the manager of the Alger Small Cap Focus Strategy. 

AMY ZHANG:  Thanks, Kevin.  So, it’s great to celebrate my three year anniversary for managing the Alger small cap focus products.  I spent over 15 years managing focus, high conviction, benchmark agnostic, small cap growth strategies.  I think my process is a natural fit with Alger’s overall investment philosophy, but also helps diversify the product lines with a focused small cap strategy.  

KEVIN:   I just want to ask you a little bit about volatility in the markets.  How are you factoring in volatility in your management process with this strategy?

AMY:  I think volatility is just a way of life, especially with different market cycles.  Having said that, I still think we will continue to be in a bull market, since global synchronized growth led by the U.S. is very strong.  Overall, we continue to focus on stock selection and evaluation to potentially achieve attractive risk-adjusted returns.  I think this will be a stock picker’s market, which should be favorable for actively managed strategies, especially as the small cap space is really a very volatile space.  So, for us it’s really important to have our bear, base, bull cases, especially as we focus a lot on the bear cases.

So, we typically buy when the stock is 10 to 15 percent, sometimes 20 percent in a bear case.  And I always get excited when there’s a significant disconnect between fundamentals and stock price.  And that’s why volatility is really driven by a lot of non-fundamental reasons.  So, we try to take advantage of that and use volatility as our friend

KEVIN:  Of course, Small Cap Focus is just one of Alger’s focused strategies.  What do you take into consideration when specifically managing a focused portfolio?

AMY:  Well, I always believe in investing in high conviction companies.  Since stock selection has always been my competitive advantage and we’re benchmark agnostic, we really just only make investment decisions based on in-depth, fundamental bottom up research, not a benchmark – unlike most of my industry peers.  They’ve been managing their portfolios by overweighting and underweighting the index.  I think one of the key benefits of having a focus strategy is that we know our companies exceedingly well.

So, I think owning a relatively small number of positions enables us to become experts on companies in the portfolio.  For me, truly understanding what we invest in is of paramount importance.  And we can pay acute attention to our holdings and not be distracted with too many positions.  So, that typically will lead to high conviction, bigger position sizes, and potentially more alpha generation.

Being a small cap space, we’re more likely to unearth companies earlier in their corporate life cycle that are under the radar and less followed by Wall Street analysts.  So, we always have a differentiated view and aim to invest in our highest conviction names, regardless of sector.  And I always think understanding reduces risk.  By focusing on fewer companies and knowing them very well, we reduce the risk of our investments.

Moreover, we keep the volatility of the portfolio lower, generally, by investing in high quality names with a wide moat, strong cash flow generating capabilities, and little or no debt.  So even though we run a focus portfolio, in terms of our end customer exposure it’s quite diversified.

KEVIN: What is the size of the universe of companies that you’re selecting from? .

AMY: The universe is very large.  It could be 20,000 companies.  We define smallness in terms of revenue.  So generally, we invest in companies at an initial point of investment with 500 million or less in revenue, because we believe that revenue is a better indication of size than market cap.  So, that narrows down our universe.  We also look for: very strong financial metrics, sustainable growth, companies with differentiated products and services in larger growing markets that are still fragmented enough that a company can remain dominant, and exceptional small companies that we believe have disruptive technologies and scientific innovations that can drive long term revenue growth and profitability.  So, we actually just keep an inventory list of over 100 companies.  But it’s just very important to keep the pulse of what’s up and coming, what’s emerging.  So, we have an inventory list of potential candidates for us.  And that’s a dynamic list.

KEVIN: What are some of the investing themes that you and your team are currently focused on?  No pun intended.

AMY: Innovation is a common theme.  Our typical holdings, products and services will have strong value proposition and usually in a technology area.  Eighteen of our companies – about 40 percent of our portfolio by position size – have exposure to big data and artificial intelligence and machine learning.  So, that is a key theme for us, because we think artificial intelligence, machine learning with big data, will create incremental revenue opportunities for application vendors since a greater number of enterprises will embrace that data science to lower cost and automate work flows and manually intensive processes.
We have companies that specialize in price optimization using data science, for over 30 years. We have a company that has been automating manufacturing processes by machine vision.  The company has been doing that for over 30 years.  So, that really is at the core of what we do.

The other area is the Cloud adoption.  There’s an ongoing secular shift to Cloud deployments over Legacy on premises.  So, most of our companies have shifted to Cloud.  Their customers are moving to Cloud.  So, that’s very important.

One company, for example, a dominant player in cybersecurity, is using Cloud.  Most of the cybersecurity companies are still using on premise.

Healthcare is a very important area for us.  We’ve always invested in a lot of diagnostic companies.  Diagnostic includes food safety and animal safety.  But a lot of our healthcare companies are also technology companies.  For example, they automate the clinical trial process, and the CRM function for live science companies.  So, the Cloud for healthcare can expand into other areas.

KEVIN:  Amy, we’ve spoken about this before.  What differentiates the way you manage Small Cap Focus versus your industry peers? .

AMY:  So, there are aspects of our approach that set us apart, and they really support our goal of identifying exceptional small companies that have the potential to become successful large companies.

We run a focus portfolio with less than 50 holdings. That might sound risky to some investors, but our portfolio has lower volatility, since our beta is generally less than one, and our standard deviation is generally lower than the benchmark.

We define smallness in terms of revenue, because we think revenue is a better indication of a company’s size than market cap.  We’re benchmark agnostic and our portfolio holdings are not household names.

I think most of my industry peers have been closet indexers as they’ve been managing the portfolio by under- weighting and over-weighting the index.  And I’ve been doing high conviction portfolios for over 15 years.  I do not manage the portfolio by overweighting or underweighting the benchmark, and we do not sector rotate.  For us, it’s all about fundamental, bottom up stock selection.

KEVIN:  Finally, do you think small cap will outperform large cap growth this year?

AMY:  Well first of all, small cap has lagged large cap since the end of 2013.  And historically, small cap has outperformed large cap.  And stronger GDP growth, higher interest rates, and inflation and tax reform should all provide a stronger tailwind for small caps, because typically when we have rising interest rates that means the economy’s very robust.  So, that’s why I think small cap should outperform large cap in the next one to three years.

KEVIN:  Amy, thank you so much for speaking with us today.

AMY:  Thanks, Kevin.  Great talking with you.

KEVIN:  And thank you for listening.  For more information on the Alger Small Cap Focus strategy, please visit alger.com.

CLICK HERE for more information on the Alger Small Cap Focus Strategy.​

The views expressed are the views of Fred Alger Management, Inc. These views are subject to change at any time and should not be interpreted as a guarantee of the future performance of the markets, any security or any funds managed by Fred Alger Management, Inc. These views should not be considered a recommendation to purchase or sell securities. Individual securities or industries/sectors mentioned, if any, should be considered in the context of an overall portfolio and therefore reference to them should not be construed as a recommendation or offer to purchase or sell securities. 

Investing in the stock market involves gains and losses and may not be suitable for all investors.  Growth stocks tend to be more volatile than other stocks as the prices of growth stocks tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political, and economic developments.

Small Cap Securities Risk – there may be greater risk in investing in companies with small market capitalizations rather than larger, more established issuers owing to such factors as more limited product lines or financial resources or lack of management depth. It may also be difficult or impossible to liquidate a security position at a time and price acceptable to the Fund because of the potentially less frequent trading of stocks of smaller market capitalization.

Founded in 1964, Fred Alger Management provides investment advisory services to institutional and individual investors through traditional and alternative strategies in a variety of products, including separate accounts, mutual funds and privately offered investment vehicles. For more information, please visit www.alger.com.