Why small caps offer big opportunities for investors

Investors are missing out on the chance to build long-term wealth because small-cap companies are being overlooked by the market, according to a portfolio manager.

David Barr, president and CEO of PenderFund Capital Management, helped launched his company’s Pender Small Cap Opportunities Fund in 2009 and has grown it to a little under $200 million in assets under management.

He believes that small caps often do not “move the needle” for professional investors, while others are put off by the misguided perception that they are higher risk.

Barr also said the key to unearthing undervalued small-cap gems lies in carrying out vigorous due diligence; something not every portfolio manager is prepared to do.

He said: “There’s not as much information available on them, so you have to go out and do your own original work to figure out which ones are the good ones and how much you should be paying for those companies.

“That tied in for us because we came from private equity, where when you’re investing in a private company you have to go and do your own deep-due-diligence dive on the company, industry, the market and the people involved in order to make your investment decisions.”

Barr said an attractive small-cap company is in the early innings of a big market, which points to a better chance of getting a “really long-term, wonderful growth rate”.

He said: “When you think you have that, that’s when you can dive in and look at whether this is a management team we want to work with and what the actual economics of the business are. Yes, they have a product but are they able to produce it at margins that will drive significant cash flow going forward?”

The fund has won a Lipper award for best Canadian Small/Mid Cap Fund over 3 and 5 Years for the past three years. It currently has 86.2% Canadian equities, with the biggest sector allocation being information technology (40.8%), and Barr said this preference sets them apart from a lot of other funds.

He said: “It’s a bit unique for someone as active as we are in Canadian small cap because most people have significant weighting in oil and gas, or other resources.

“We try to find businesses with deep competitive advantages and if you look at resource industries, they are a commodities business and they are price-takers, and those tend to not be wonderful long-term investments.

“Information technology is where you find companies that are highly scalable businesses. They tend to be in the early innings; a company has found a new problem to solve and it might be a really big market. So this is where you can find these businesses that can really grow at wonderful rates for a long time.”