Intrepid Capital Funds’ Vice Presidents Matt Parker, Joe Van Cavage, and Hunter Hayes weigh in on common misconceptions and opportunities in the small-cap value universe, and the long-term benefits of active management.
There are many untapped opportunities in the small-cap asset class. From a historical perspective, small-cap value is higher risk but higher reward. It has very strong long term results and is one of the best long term equity options. Unfortunately, in the last 18 months small caps have struggled. Common criticisms of small-cap assets are their limited access to capital and the lack of net capital flowing to small-cap value. Additionally, monopolistic factors work against the asset class. Most investors would be surprised to learn that 44% of the Russell 2000 Index is unprofitable and 1/4th of the index has a meaningful amount of financial leverage. Small-cap values underweight information technology by 17% and communications services by 9%. Meanwhile, the values overweight financials by 17%.
Intrepid Capital Funds admits that there is a lot of truth to the faults levied against small caps, however, it would be naive to throw out all the investment opportunities in the asset class. Investors need to consider the market’s history of innovative disruption; it is not realistic to believe that the same companies will always dominate the marketplace. The team emphasizes that price matters and impacts future returns. While small caps have a higher cost of capital, this is already reflected in their valuations. Finally, the asset class is overdue to come back into favor. Finding the best options for small cap investing requires an active approach. Intrepid Capital Funds strives to cut out unprofitable, highly leveraged, and structurally disadvantaged companies from consideration. They look for companies that have non-tangible value, not just the cheapest stock. Lastly, they remain flexible by not enforcing sector or geographic constraints. This method of investing results in an enduring portfolio that has the flexibility to prosper through market booms and busts with lower long-term volatility.
Short duration fixed income is another asset class that can accrue impressive results if wisely and actively managed. Intrepid Capital Funds explains that the 10 year Treasuries have been trending downward for the past 30 years. This is important because the risk-free investment rate directly impacts risk assets. Additionally, cheap debt has been a valuable sustenance for corporations in recent years. Taxable fixed income has two main options for investors to pursue. The aggregate option consists of investment-grade, government, and ABS, MBS, and CMBS opportunities. The other option is high yield. When navigating across the fixed income asset class, Intrepid Capital Funds focuses on small, creditworthy issues. They look for free cash flow, well-rounded asset coverage, and consistent absolute returns.
Founded in 1995, Intrepid Capital Funds aims to give investors a competitive advantage by adopting a long-term focus, remaining disciplined, and focusing on absolute returns. They are co-invested in the same strategies as their clients, demonstrating their commitment to each individual’s success. Intrepid Capital Funds is also an independent, private firm so their priorities always lie solely with their clients.
To learn more, register for Intrepid’s recent webcast: How to Order off the Small Cap Value and Fixed Income Menu.
The pandemic has highlighted the importance of investing in well-positioned companies with strong fundamentals. Some asset classes, such as large cap stocks and investment grade bonds, tend to have a greater concentration of these businesses and be a good match for passive strategies.
For other asset classes, such as small cap value stocks and high yield bonds, advisors can benefit from a more active approach and not ordering everything on the index’s “menu”.
- Avoid the structurally disadvantaged part of the small cap value market
- Reduce volatility in these more volatile asset classes
- Maintain flexibility to manage through booms and busts
- Search for higher yields but low interest rate and credit risk