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Small Cap investing - Finding coal and watching them grow into diamonds

The portfolio managers in the European Small Cap team rarely have an investment bank analysis they can refer to before investing in a company. Instead, they have to do all the analysis legwork themselves but the advantage is that they often find diamonds in the rough.

“Discover unknown small caps, only invest in quality companies and be patient.” This sentence sums up the investment philosophy in the European Small Cap team. 

Besides the part about quality companies, the philosophy might seem a bit unconventional if you compare to investing in large caps. The reason is that the European small cap investment universe is rather different from the regular large cap universe. One of the main reasons is the absence of analyses, as investment bank analysts don’t give small caps much attention. 

“Very few analysts are interested in small caps. We don’t have an analysis where we can study cash flow in the last five years or check a company’s market share. We have to do all the analysis ourselves; go through the accounts meticulously, meet the management team and meet the company's suppliers and their competitors,” says Chief Portfolio Manager Christian Rasmussen.

He is, along with Alexander Zola, the responsible portfolio manager for the Danske Invest Europa Small Cap fund – a fund that has doubled in assets under management during the last year.

Finding hidden gems in niche areas
Christian Rasmussen thinks that the exciting part of the hand-held analysis is that if you do your due diligence, it is possible to find hidden gems that are completely unknown to the public. Especially as share prices and fundamentals often are decoupled in the European small cap universe.

”We can easily find anomalies in our universe - companies that are undervalued but have great potential. We sometimes find companies that are completely unknown but market-leading in their field,” says portfolio manager Alexander Zola.

The hidden gems are often companies that operate in a niche area where they supply large brands with some sort of component and do co-developments. 
One example is the British company Treatt that provide flavour and fragrance ingredients to the consumer goods market. Their citrus flavours are added to various tonics all over the world and they are expected to benefit from the increasing consumption of the flavoured sparkling water with alcohol, the so-called ‘hard seltzers’, in the US. The European Small Cap team invested in the company in 2018.

Another example is a Swedish company, Mips. The company has been in the fund since 2020. Mips provides a patented extra safety system into sport and safety helmets – a system that is developed to prevent the user from getting a concussion. The system was invented when a doctor started wondering why so many people got concussions in biking accidents although they wore a helmet. He invented the extra safety system, now symbolised by a yellow dot.

Companies overwhelmed by visit
Typically, the Small Cap team owns around 3-5% of the company and therefore, the management teams often have a strong incentive to keep Christian Rasmussen and Alexander Zola up-to-date.

In some cases, they are the first major institutional investors to visit the company. 

“Before the pandemic, we visited a company in the South of England. They were quite overwhelmed by our visit, as they hadn’t had many investors dropping by and certainly not from the continent. The English investors were waiting for them to come to a roadshow in London with other small caps,” says Alexander Zola.

Visiting the companies is an important part of the investment process as it gives Alexander Zola and Christian Rasmussen a good impression of what kind of people the management team consists of and a sense of the company culture. Even though Teams meetings, online product demos and online lab tours have added an extra dimension to the analysis, they are looking forward to getting on the road again once travel restrictions are lifted.

Being patient
As a final statement, Christian Rasmussen and Alexander Zola would like to stress that it is important to be patient when investing in small caps.

“We are in it for the long-haul. We don’t buy and sell every week as we rarely see huge changes overnight. Due to the inefficiency in the small cap universe, it may take time before the underlying value of a company is reflected in the share price,” they comment.

Four facts on Danske Invest Europa Small Cap

- Focuses on stocks from EUR 100 mn. to EUR 5 bn in market cap. 
- The average market cap is around EUR 1bn
- Managed by portfolio manager Christian Rasmussen and Alexander Zola
- The investment horizon is 3-5 years
Disclaimer: 
The statements in this article is neither investment advice nor an offer or solicitation of any offer to purchase or sell any financial instrument. Always be aware that investment involves risk and that historical performance information is not indicative of future performance or investment returns, which can be negative. Please consult with your professional advisors about the legal, tax, financial or other matters relevant to the suitability and appropriateness of an investment.

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