A frequent topic of discussion in the investing world is idea generation — how do you best come across great investing opportunities? Among the typical avenues that institutional investors explore are conferences, management roadshows (where a broker brings a management team to see investors in a city), screening tools, and their own professional networks.
All of these avenues have their advantages and disadvantages and merit their place in the investor toolkit. Excluding screening tools for a moment, an important characteristic that these avenues share in common is that investors do not take part in the initial filtering process. Conferences typically feature a subset of companies selected by the conference’s host, management roadshows are arranged by brokers and favor those companies with (a) a greater focus on investor access and (b) a routine need to access capital markets; and a professional network provides you with a set of companies filtered by someone else’s unique likes and dislikes.
Coming back to screening tools, while investors set the parameters that filter the companies on-screen, the input data are purely quantitative and not always reliably accurate — which means good investment opportunities can get filtered out. Long story short, investors outsource a lot of the filtering in their investing process, which (especially in the small-cap universe) may lead to some great companies with less investor outreach or no need to access capital markets falling through the cracks.
Going A through Z and investor road trips
On our Global Small Cap team, we cast our net very wide to put a large number of companies through our filtering process. Naturally, the more that goes into your filter, the pickier you can be, and we are very picky! For this reason, we do not solely rely on the traditional idea generation channels mentioned above, but also employ the cumbersome process of going “A through Z” in any given country. Earlier this year, we went A through Z in Germany for every company between about US$150 million and US$10 billion in market capitalization, which was in the vicinity of 300 companies. From there, we narrowed our list down to about 30 companies that fit our stringent criteria. We then arranged an investor road trip, travelling through four states in Germany, to visit a subset of the selected companies. The process was undeniably intense, but it led to three key takeaways.
- Finding hidden gems
Of the companies that we visited, roughly 40% did not attend a single international conference in 2018. Furthermore, approximately 40% were not covered by a single bulge bracket broker (a term that refers to the largest brokers whose research reports have very wide circulation, thereby reaching lots of institutional investors). To zero in on the overlap, 25% of these companies neither had bulge bracket broker coverage nor presented at an international conference in 2018. This detective work has borne fruit as the Invesco Global Small Companies Class has invested in one of the companies falling into the 25% bucket, and one falling into the 40% bucket.
- Management access
Access to management is usually of higher quality via an investor road trip than via a conference. In a conference setting, meetings often have to be shared with a small group of other investors and usually run for about 30 to 60 minutes. In contrast, during our recent road trip, we had one- to two-hour meetings with top management — without having to share the face-to-face time with anyone else. On top of that, we got to see management in their own environment. No matter what the annual report says, we believe few things tell you as much about how tightly a CEO really holds the purse strings than to see the environment where they go to work every day.
- Active versus passive investing
Another interesting insight raised by this exercise is the merit of active versus passive investing. To use Germany as an example, only about 10% of the companies in the US$150 million to US$10 billion market capitalization range passed our stringent quality criteria. This highlights that even in a country as economically strong as Germany, the high-quality companies (as per our criteria) are in the absolute minority. But what about a country like the U.S.? In our view, the S&P 500 comprises an extraordinary group of companies, which makes it a benchmark that’s very hard to beat over the long term after the burden of fees — and thus a frequent topic of discussion in the active versus passive debate. However outside of the S&P 500, and especially in countries outside of the U.S., investors have to be a lot pickier when it comes to business quality, which makes the merits of active management outside of the U.S. that much greater.
While a lot of work to set up, investor road trips together with an A-Z filtering approach can be a very useful tool in the investor toolkit, especially in a global small-cap fund. In addition to the immediate investing opportunities yielded by our Small cap team’s recent trip to Germany, this exercise has allowed us to add some great German companies to our wish list.
Note: While we referenced the Invesco Global Small Cap team in the examples above, we employ the same investor road trip approach for the Invesco U.S. Small Companies Class, usually on a city-by-city basis.