Transcending Volatility in Small Cap Growth

1. What inefficiencies exist in the small cap growth space?

Investing in the U.S. small cap growth universe provides the opportunity for attractive returns; however, the universe is comprised of many less mature growth companies that have the potential to exhibit greater volatility in their business fundamentals and therefore greater volatility in stock prices.

2. How does your investment approach capitalize on the inefficiencies of volatility in the small cap growth space?

First, we utilize an extensive stock-specific research process designed to help identify companies with fundamentally stable growth characteristics. These companies can grow sales and cash flows at a higher rate and more consistently than their peers that exhibit more volatility in these metrics. We focus on these types of companies because they have historically delivered higher returns with less risk compared to peers with less stable growth characteristics and compared to the overall small cap growth universe.

The second way we seek to capitalize on the volatility is by making the sell decision just as important as the buy decision. We use three primary tools to guide our sell decisions—in-depth fundamental analysis of risk, rigorous valuation modeling, and a proprietary risk screening tool—we call it our “check engine light”. This tool systematically flags stocks at risk of underperforming due to fundamental deterioration in sales growth, earnings quality, return on capital and a company’s competitive advantage. Erosion in these factors can lead to stock price volatility and underperformance which is why the sell discipline is such an important part of our process.