value and opportunity

Performance review:

In February, the portfolio performed +2,7%, which is -2,5% lower than the Benchmark (25% Eurostoxx 50, 25% Eurostoxx small, 30% DAX and 20% MDAX). YTD, the portfolio is up +6,5% vs. 3,2% for the Benchmark.

Main contributors for February were G. Perrier with +22,5%, TGS Nopec with +16,9%, SIAS with +10,4% and IGE & XAO +7,1%. Major looser was Cranswick with -5% (in EUR) and Vetropack (-2,8%).

Portfolio transactions

If I look at my transactions in February, I almost feel like a high frequency trader: I sold the final Rhoen Klinikum position as well as EMAK and SOL. I increased positions in MIKO and TGS Nopec and finally I invested in 3 (!!!!) new stocks: Energiedienst, Koc Holding and Ashmore. Cash is now at 13,5%.

The current portfolio can be found here.

Comment: “Is small still beautiful ?”

2014 again showed the usual pattern in the past few years: Small and Midcaps outperform everything else by a wide margin. This is how the constituents of my own benchmark performed YTD:

	Perf. YTD
Eurostoxx50 (Perf.Ind) (25%)	1,51%
Eurostoxx small 200 (25)	8,06%
DAX (30%)	1,46%
MDAX (20%)	1,91%

So European small caps seem to be THE hot asset class. A long time ago, when I went to university (early nineties), I still remember when the finance professor talked about efficient markets. He didn’t believe in them and one of the example quoted was the famous “small cap” effect, the “fact” that small caps over the long run perform better than large caps.

Looking at most markets today, the history speaks for itself. Just look at the Charts:

S&P 500 vs. Russel 2000

or even more drastic: Dax vs. MDAX

Back to the “old times”: When I started to work for a financial institution in the mid nineties, one of my job was to monitor and explain the performance of a German small/mid cap fund. Every Quarter or so, I had to explain why again the fund had underperformed the DAX by a wide margin and the fund was finally closed end of 1999. Just to give an indication how badly Midcaps performed in this period: From the end of 1994 until end of 1999, the DAX performed ~26,4% p.a. against the MDAX with 10,6%, an underperformance of -16,4% p.a., or in absolute terms +221,96% against 65,55%. No matter what academia would say, the decision makers were tired of looking stupid and pulled the plug.

Consensus at that time was that in the age of globalization, the big international companies would be the stars and the small companies would be crushed. We all know how this story ended.

Let’s look at some more recent numbers: Since the end of 2009, the MDAX has performed 21,5% p.a. vs. 12,4% p.a. for the Dax. The French Small&Mid Cap index has performed 13,9% p.a. vs. 5,95% for the CAC in the same period. So again, many “asset allocators” are faced with a situation, where the logical thing to do is to allocate as much as possible into the much better performing asset class.

However, this past performance is only one side of the medal. Let’s again look back and look at something else this time: Valuation

When my employer at the end of the nineties decided to pull the plug of the small/midcap fund, the DAX was trading at a P/E of 32 vs. the MDAX at 16. Interstingly enough, the situation now is just the inverse: The MDAX now trades at 28 times earnings against the DAX at around 16 times. The situation looks similar in other markets. The Russel 22000 for instance trades at ~50 times 2013 earnings against 17x for the S&P 500. Of course, profits in small and midcaps could continue to grow much faster than in large caps, but at current valuation levels they have to grow much faster than for large caps in order to justify their valuation.

There seems to be so much money flowing into small caps at the moment that even the weak companies enjoy their day in the sun. So what to do now ? Chase the few remaining “cheap” small caps and hope that they get pushed up by the momentum ? Or exit completely ? I don’t know, but for instance European small caps have almost completely disappeared in my BOSS score database from the “attractive” bucket. The few remaining ones are rather “deep value” cases.

In any case, one should be very careful with small caps going forward. Based on current valuations, profits at most small cap companies (Europe and US) would have to increase really strongly in order to be able to produce additional outperformance in the next few years. There might be a few remaining opportunities, but overall “the air is getting thinner”. We will see how this plays out, but experience shows that multiple expanions will stop at some level and then usually reverse quite drastically and for long time periods. So be careful with small caps. Maybe “big is beautiful” might come again….