It’s time for small businesses to shine

Now this is proving to be a “very exciting time to invest in small businesses,” says Shadman Riaz, Co-Director of Fidelity Small Cap Stock Selector (symbol FDSCX). A growing economy and higher interest rates create a good environment for small cap stocks. Plus, a rush for initial public offerings means there are more companies under the radar in the market – and thanks in part to the popularity of indexing, fewer analysts looking for them, Riaz says. All in all, “there is an opportunity for active managers to outperform,” he says.

Stock Selector Small Cap has a unique configuration. Five managers manage the fund, but the portfolio is divided into three different legs, which are managed separately. Two parties hold a diverse mix of stocks across many industries. One of them favors growing, high-quality businesses; the other leans towards so-called cyclical, or economically sensitive, value-oriented opportunities. The third round focuses only on health care stocks.

Managers collaborate, but they don’t work by consensus. “We make individual decisions,” says Riaz. However, they all look for companies with a competitive advantage, led by smart executives, that trade below the managers’ fair value estimate.

Regardless of their place in the overall portfolio, stocks in the fund generally meet one of three sets of criteria. Some companies are stable businesses with strong competitive niches, crisp balance sheets, and reasonable valuations. Business service provider ExlService Holdings “is growing at a strong pace and has good cash flow,” says Riaz. Others are innovative companies with products in demand. SiTime, for example, integrates timing devices into gadgets like headphones and smartphones to help them sync up quickly. The third group includes disadvantaged cyclicals. The HollyFrontier oil refinery, for example, trades at a low price relative to book value (assets minus liabilities), Riaz says.

The structure of the portfolio has given good results. Over the past three years, the fund’s 18.6% annualized return has outperformed 97% of its low-interest peers (funds that invest in small companies geared towards growth or value).

Table with statistics on the 20 largest stock and bond mutual funds

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