Interviewer: How did you first get interested in small cap investing, and how has that developed in your time at Crawford?
Boris Kuzmin, CFA®: I became interested in smaller companies early in my investing career. My interest stemmed from the fact that this is an underfollowed part of the market that offers diligent investors opportunities to earn outsized returns. At Crawford, we have historically focused on the large cap segment of the market. However, we have frequently observed that companies at the low end of our investable market cap range exhibited attractive fundamental characteristics. After doing some back-testing, and given our desire to expand our product suite over time, we identified the small cap space as a great opportunity to apply our existing investment approach and generate attractive, risk-adjusted returns for our clients.
I: Could you talk about that potential you saw and how it relates to both your investment approach as the Small Cap Strategy Director and Crawford’s overall investment philosophy?
BK: Since its founding, our firm has consistently been focused on investing in what we believe to be undervalued, high-quality dividend-paying companies. While we have found that this approach works really well in large caps, particularly from a standpoint of mitigating volatility and downside risk, it works even better at the smaller end of the market spectrum. We believe that there are several factors at play here. One, there seems to be a persistent phenomenon of neglect for dividend-paying small cap companies among Wall Street firms, which limits the amount of information available to less-sophisticated investors. Additionally, the quality disparity is much wider within small caps when compared to large caps, as most investors underestimate the level of risk that they are taking on. When you couple this quality disparity with the fact that small cap companies are underfollowed, a number of inefficiencies emerge and often lead to stock mispricing.
In short, we believe our quality bias works really well in the small cap space. As I mentioned earlier, when we were in the process of developing the strategy, we went back and looked at how quality had performed historically within small caps. What we saw was this really significant benefit of being invested in higher-quality companies, both in terms of risk reduction and return advantage. This benefit was particularly pronounced when a company’s dividend-paying history was used as an indicator of quality.
I: How do quality and value coexist in your portfolio?
BK: Quality and value are not mutually exclusive. Small cap stocks tend to be a lot more volatile because of both lower liquidity and the fixation on short-term results exhibited by many investors. This results in frequent mispricing opportunities where even high-quality companies can trade at sizable discounts to their intrinsic value and/or their peers. You wouldn’t normally think of high-quality companies as being “cheap,” but it does happen. At Crawford, our research team consists of sector experts who follow their assigned areas in great depth and can quickly spot undervalued stocks.
I: I know you like to use the phrase Quality At a Reasonable Price — QARP. Can you elaborate on this and explain its relationship to the Small Cap strategy’s value tilt?
BK: In addition to buying what we believe are significantly undervalued stocks, we are willing to pay a reasonable price to purchase companies that we believe have a solid growth trajectory and are well positioned for the future. Purchases of this nature may not always fall into a traditional definition of “value,” but as long as we believe that valuation is reasonable relative to the longevity and consistency of growth prospects, we will consider buying a security, hence this QARP moniker, as compared to the more well-known GARP or Growth At a Reasonable Price.
I: Could you talk a little bit about what triggers a decision to sell a holding in the Small Cap portfolio?
BK: We do have a $10B market cap threshold to keep our portfolio focused on smaller cap companies. Ideally, we would buy a company at or around a $100MM market cap, let it grow to $10B, and then either sell it or have it graduate on to our SMID Cap strategy. Additionally, we are constantly looking for new investment candidates and evaluating them against the stocks we already own. So, if we identify a better risk/reward opportunity, we will make the swap. We also monitor changes in a company’s dividend policy. A dividend cut automatically triggers a review and re-underwriting of our investment thesis for that stock. In a case of complete dividend elimination, it is an automatic “sell.” However, we do give ourselves a year to exit the position. This helps us avoid a “knee-jerk” reaction when virtually everyone else is also trying to exit the stock and allows us to find a better exit opportunity down the road.
I: What challenges do you see within the small cap space?
BK: In general, one challenge in the small cap area is that stock performance tends to be more momentum-driven. Investors often chase smaller stocks primarily because they are going up. This dynamic leads to stock prices being detached from fundamentals and can last for some time. Thus, small cap investing requires patience and high conviction in the companies that you own.
Along the same lines, with our focus on quality and downside protection, we may not always fully participate in “hot” markets or during “risk-on” environments. There are certain groups of stocks (generally lower quality) that we believe tend to do well in these environments, so this can create temporary dislocations or periods of relative underperformance for us. It happens periodically, so we live through it and strive to rise to the challenge of sticking with our discipline and not getting caught up in what really turns out to be speculation, rather than long-term investing.
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Crawford Investment Counsel, Inc. (“Crawford”) is an independent registered investment advisor. Registration does not imply a certain level of skill or training. More information about the advisor including its investment strategies, objectives and fees can be found in its Form ADV, Part 2 which is available upon request.
This interview took place in November 2020. The opinions expressed are those of Crawford. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. This document may contain certain information that constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology. No assurance, representation, or warranty is made by any person that any of Crawford’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future.
Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The investment strategy or strategies discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances.
Chartered Financial Analyst® (CFA®) are licensed by the CFA® Institute to use the CFA® mark. CFA® certification requirements: Hold a bachelor's degree from an accredited institution or have equivalent education or work experience, successful completion of all three exam levels of the CFA® Program, have 48 months of acceptable professional work experience in the investment decision-making process, fulfill society requirements, which vary by society. Unless you are upgrading from affiliate membership, all societies require two sponsor statements as part of each application; these are submitted online by your sponsors. CRA-20-222
The opinions expressed herein are those of Crawford Investment Counsel and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements cannot be guaranteed. This document may contain certain information that constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology. No assurance, representation, or warranty is made by any person that any of Crawford’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future. Crawford Investment Counsel is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training.
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