Brad McGill, manager of Aperture Discover Equity Fund
Brad McGill, manager of the Aperture Discover Equity Fund (part of Generali Investments) tells us why small US companies are an attractive option for investors. According to McGill, a selective strategy, strict risk guidelines and a process for identifying competitive companies are part of the characteristics that make the Aperture Discover Equity Fund the best alternative in the US small-cap sector.
Why should an investor consider Aperture Investors SICAV – Discover Equity Fund over a typical US small cap fund?
There are a few things that make us a bit different. I’ve spent over 15 years specialising in small cap stocks and have found that a very selective, concentrated strategy can be advantageous for investors. At Aperture, we limit our capacity to preserve the opportunity set for investors and prioritize alpha generation, as opposed to some competitors with many positions and several billion-dollar AUM small cap strategies. Secondly, we have a very clear set of time-tested investment criteria that we follow with a lot of discipline. Thirdly, we have a long-term time horizon and invest for 2-4 years on average. We don’t run a coverage model and don’t aim to have an opinion on every stock in the investable universe. Instead, we focus on a small, high conviction basket of ideas that we believe can appreciate over 50% or more over a two-year period. These features, in my view, create a differentiated portfolio compared to many of our peers.
The fund typically holds 20-30 stocks, and up to 15 short positions. How do you manage concentration risk?
We adhere to strict risk guidelines. For every position, we create upside targets and downside risk thresholds. We target a minimum of 50% upside and every stock has a 3-1 asymmetry in terms of upside relative to downside. We pair these guidelines with our very clear investment criteria set. We continually review the key drivers and milestones of companies to assess if our thesis tracks our expectations and criteria. Position sizing is determined by confidence levels and our expected range of outcomes. At the portfolio level, we consider beta-adjusted exposure by sector and position, volatility, and other risk factors.
Given the nature of small cap stocks being under- researched, how do you identify which companies are worth investing in and conversely, which ones to short?
We have a very clear sourcing process designed to consistently identify competitive companies that we believe are undergoing positive transformational change. As a small team, we turn the traditional sector coverage model on its head. We look for unique companies within sectors and indeed our portfolio does not mirror the benchmark.
Our investable universe includes over 2,000 US small caps, but we narrow this down and focus on about 300 a year to find the seven to ten ‘best ideas’ that we find compelling. In terms of shorting, we only short with an aim to generate a positive absolute return for our investors. These ideas typically arise naturally from our investment process, so it could be a company that we previously researched as a long candidate.
Could you illustrate a few of the themes you currently hold in the fund, both on the long and short side?
We typically gravitate towards companies within consumer discretionary, information technology, services, industrials, healthcare, and materials sectors. These opportunity sets tend to be more sensitive to positive change than, say, a utility or financial where the macro environment often dictates performance more than idiosyncratic company specifics. We look for companies in dynamic periods of their life cycles where their business models are becoming optimized and they’re growing into the ‘leaders of tomorrow’, as we sometimes say. This could be a small cap that we discover early and grows into a successful large cap. It could also be a smaller business with a particular niche that hasn’t been well managed historically, but a new CEO comes in and turns the business around.
Given gloomy global macro sentiment, rising recession risk and high volatility, why should investors consider this fund now?
I think it’s actually a very interesting time to be considering allocating to the US small caps. Although it is certainly debatable if we have seen the lows of this market selloff, it is notable that after bear market bottoms historically, small caps have dramatically outperformed large cap equities and delivered strong absolute returns. In addition, small cap valuations in many cases have already reached recession levels. While clearly there may be some earnings risk ahead, small cap multiples have generally already discounted a lot of the potential deterioration in earnings, more so than in large caps. For long-term investors, these market dislocations have provided great opportunities to upgrade into compelling situations at attractive prices. So, the starting point here is quite attractive. We optimize the portfolio during market downturns, adding new positions and increasing existing ones, which is exactly what we’re doing now.