Broker cutbacks boost small-cap opportunities

With the tightening of belts at big stock broking firms in the past couple of years, particularly the firms which are owned by banks, has come an increase in the opportunity set for buy-side researchers.

According to Robert Feldman, portfolio manager and head of global small caps for Pyramis Global Advisors, the “sell side” research departments of broking firms have been cut back and their coverage of the market reduced because of the global financial crisis.

“This has created more opportunities for buy-side research,” he said, meaning the analysis performed by funds managers and in-house teams of big pension funds.

Pyramis, which is Fidelity Investments’ non-US investment manufacturing arm, has the biggest team of analysts of any manager in the world. There are 395 in total, 215 of whom are in the US. The firm has major offices in London, Hong Kong, Tokyo, Singapore, Sydney, Germany, France and Mumbai. It manages about US$2.5 billion in small-cap funds.

The firm has been investing in international (non-US) small-caps for about 15 years and has had a true global fund since 2007.

While some large pension funds have recently looked to expand their in-house active management to include small-caps, Feldman believed that most are very unlikely to go down that route.

“You need a vast army of resources, including people on the ground, to do it well, unless you’re running a quant process,” he said.

Small-caps tend to be more locally focused – less international – than large-cap stocks. They also tend to have one main business line which makes them easier to understand than diverse conglomerate companies.

“If you buy GE, you may as well just buy the whole market,” Feldman said.

He believed that emerging-market small-caps would develop into a separate asset class within the next few years as more and more investors were looking to tilt their portfolios towards higher growth regions and away from the developed markets.

The Pyramis funds are broadly sector and region neutral, with value-add coming primarily from stock selection. The average market cap of each stock is $1.8 billion but the manager will buy within the range of $3 billion down to $100 million.

Feldman personally reads every research note written by the analysts on a daily basis – sometimes more than 100 per day.

He said mostly they were updates of stocks which were already invested and he was primarily looking for new ideas. He also tried to personally interact with the analysts as much as possible.

“The informal part of the job is very important too,” he said.