MICROEQUITIES, MACRO HOPES: THE RUNDOWN ON INVESTING IN SMALL CAPS

Carlos Gill

The debates over investing in small vs large cap stocks often miss central points – and can descend into absurdity. For example, it is entirely possible- and legitimate- to present aggregate figures which demonstrate that small caps have underperformed larger shares over 10 or 20 years, while select small funds deliver consistently superb results.

Warren Buffett invested in small caps in his early days, and individuals with self-managed super funds are now following suit. From our macro social outlook, we cannot resist the belief that, given a well-regulated financial market, the success of small cap stocks forms some kind of significant indicator of innovation, creation and economic vitality. Note, this is not a universal endorsement of investment in small cap shares – each investor must examine their own risk profile. 

For a closer look at this level of investing, Innovatia Editor-in-Chief John Keeney turned to Carlos Gil, founder and CIO of Microequities – a firm with a stirling reputation owing in part to the 16% year-on-year return from its Deep Value Fund since 2009. 

JK: Could you define “Microequities “? 

CG: Initially we used it to refer to $300m market cap and larger. We have amended this in recent years to $500m. 

As head of International Equities with a large firm previously, Banesto, one imagines you could have decided to place capital in any kind of environment.

What drew you to micro caps? 

Of course, there are growth opportunities within this category, but that remark has to be supplemented by a number of big IF’s. Some of these companies listed when very small- a case where acute examination of cashflow fundamentals and business plan, strategy and people is imperative.

Also, we do not invest in companies without at least a two-year record of profitability…and we invest in industrials only. We know our space. 

You use the term Private Equity to describe your approach, can you clarify this please? 

It refers to a number of methods and attitudes about investing. We form a kind of private business partnership with the company invested in. We use an instrument called a unit trust which provides benefits and flexibilities.

Basically, it is the mindset of taking a long-term position in a company. 

Can you elaborate? 

Yes, let me say that time is very important in investing. You cannot make 1000% in 2 years. There are some, perhaps many who equate ease of making money in moving in and out of assets, but this is wrong. Good assets will prevail time after time. Nobody actually knows when the market is going to be up or down, in a short or annual time frame. But if you have a long-term view and a solid growth asset, you will win. 

What has changed in investing as you do in the past, say, 15 years? 

Different revenue models come and go, there are some new methods of applying valuations but the basics have not changed vastly. Cash flow remains of course a predominant criterion. Perhaps the biggest alteration is in the variety and differences of business models, and the forecasting requirements this inherently creates. It makes our processes somewhat harder, and it can result in a higher discount factor. 

I believe the increase in Private Equity activity has had a salutary effect on your investments? 

Well, yes and no. Of course, when Private Equity enters, a premium is often paid, and we make a profit, but if you have our long-term view, you realize that the value after our exit will almost inevitably have been greater, in some cases much greater. 

There must be some satisfaction in knowing you saw something promising first. Returning to the nature of the micro and small cap market and our usual focus on innovation, surely – though this is hard to quantify – there is a lot of energy, entrepreneurialism, new creation in this space? 

Certainly. These companies have to innovate, they must be competitive. Looking at the sort of socio-economic view you are implying – I would say a couple of things, which are a little more from the viewpoint of the investor. What is interesting is the ability of these companies to take market share, a key indicator for me. Generally they do and this attracts Private Equity. 

And the other? 

It’s an attribute that is maybe not talked about much. But you can observe it. These companies can produce growth which is endogenous – I mean it comes from within, more or less uninfluenced by the exogenous factors, the externals, the market conditions. It’s not, of course, unlimited, but it is real and an aspect of the small innovative company I find fascinating. 

Video:

Carlos Gil, explains the investment philosophy behind Microequities small-cap investing.