Governance burdens and high fees mean institutional investors could miss out on small cap equity alpha, according to analysis from CAMRADATA.
Performance from the MSCI All World small cap index for the year to date 16 January 2023 6.41% versus 5.31% from the MSCI All World large cap equivalent. For the 10 years to 2023, small caps have outperformed their larger counterparts by 5 basis points.
Yet CAMRADATA finds pension funds and insurers “do not show a great appetite to invest in these opportunities”, partly as a move out of equities in general but also “some consultants are prepared to entertain ‘all cap’ managers and no more”.
Speaking at the CAMRADATA Small Caps Roundtable, Ian Gamon, investment partner at LCP, said as maturing final salary pension funds reduce risk allocations and where they did allocate to equities, trustee boards would not want to deal with the governance burden involved with small caps.
However, Gamon said where LCP sees more potential for small cap interest is among the growing defined contribution (DC) pension schemes, and perpetual investors such as endowments and charities.
“Where a client has a strategic allocation of more than 70% to risk assets and a truly long-term outlook, there I see appetite,” Gamon said.
However for DC investors, the potential for higher fees associated with small cap funds could present a barrier.
Mark Niznik, co-manager of the Artemis UK small cap strategy, claimed that for UK managers, capacity constraints in small cap equities are an issue.
“We need critical mass of £200-300m in total. That is enough money to get a response from company boards and get them to take our concerns seriously. It does get incrementally more difficult to run more money.”
Craig Thrasher, co-manager of global and international small caps at Kayne Anderson Rudnick (KAR), agreed that capacity constraints of small cap strategies merited a fee premium.
“Starting out of the gates, KAR has a 50-stock US$3 to 5bn versus US$100bn for a large cap manager. So costs are higher, but if you believe you can add alpha and you can demonstrate that, then the costs are justified.”
Gamon said that while capacity constraints “are an issue” it was incumbent on managers to “get the remuneration balance right.”
He said some managers combine performance fees with a low annual management charge as a helpful compromise to reward managers who deliver outperformance.
©Markets Media Europe 2023
