A quality approach for small-cap success

Over the past three years, small-cap indices like the Russell 2000 in the US have lagged their large-cap counterparts. In Europe, small caps have also endured a steep correction, trading at historic lows relative to large caps. However, signs point to a potential turnaround. Easing inflation, stabilising supply chains, and anticipated shifts in monetary policy suggest that an active approach to small caps may offer compelling opportunities for equity portfolios.

Our take on small-cap investing

With DPAM B Equities Europe Small Caps, we focus on quality growth at a reasonable price. We don't chase growth at any cost; instead, we seek high-quality companies with sustainable growth prospects without overpaying for future earnings.

Ever since its inception in 1997, our fund has been steered by a stable team of experts. This continuity has honed our team’s expertise and ensured a consistent, disciplined investment process. We employ three proprietary tools to identify companies that are not only high in quality and sustainability but also offer significant upside potential. Our “aspiration” is to see our investments double in value over a five-year horizon.

Emphasising quality and long-term value

Our investment philosophy is rooted in high-conviction, bottom-up stock picking with a long-term lens. By sidestepping short-term performance pressures, we concentrate on companies with strong fundamentals positioned in attractive, growing markets—sectors less prone to regulatory risks or fierce unfair competition from abroad.

Quality means companies with sustainable competitive advantages, high entry barriers, and strong positions in niche markets. These firms often convert their strengths into strong and/or increasing returns on invested capital, healthy margins, and excellent cash flow generation. Crucially, they can reinvest this cash at the right time in opportunities offering high returns.

Quality, growth and value over time

Source: DPAM, 2024

Another key element of our approach is backing capable management teams. In the small-cap universe, leadership can make or break a company. We look for management with proven track records, integrity, clear strategic vision, and strong capital allocation skills. When managers have significant personal stakes in their companies, their interests align more closely with minority shareholders.

Integrating sustainability and ESG principles

Our fund is classified under Article 8+, reflecting our commitment to environmental, social, and governance (ESG) principles. The investment team performs the ESG analysis themselves, which makes sustainability considerations a foundational part of their investment process. We believe ESG factors are integral to assessing a company's long-term viability and performance.

Why quality investing in small caps makes sense today

Historically, investing in high-quality companies has led to superior long-term performance, outpacing both pure growth and value strategies. Quality companies tend to weather economic storms better, thanks to sustainable competitive advantages that shield their revenues and earnings. Their strong financial positions, marked by solid cash flows and sturdy balance sheets, reduce the risk of financial distress.

Focusing on quality also minimises the chances of significant losses from companies that might underperform or fail. By holding high-quality companies over extended periods, we aim to capture compounding growth while reducing transaction costs and buffering against short-term market volatility.

Implications for investors

With small-cap stocks trading at historically low valuations relative to large caps, we see a potential window of opportunity. The combination of easing macroeconomic pressures, attractive valuations, and the prospect of a small cap rebound underscores the value of active management and careful stock selection.

Our strategy, centered on quality GARP and supported by our experienced portfolio management team, is designed to navigate the complexities of the small-cap landscape. By integrating sustainability considerations and maintaining a disciplined, long-term approach, our strategy aims to deliver value to investors seeking exposure to this dynamic segment of the market.