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Oversea smaller caps tend to get hit harder than the larger caps during drawdown such as 2022. Other than the Contrarian fund, all Grandeur Peak funds are growth-oriented, thus likely to suffer even more.
In addition, we believed, as we always have, that volatility is not a good measure of risk over the long term within the small cap equity market, regardless of which direction prices are trending. Volatility tends to distract investors and entice them to deviate from a long-term investment discipline. As a result, we try not to focus on it as a measure of risk, although that was incredibly difficult to do in a year like 2022. As we have done in the past and will continue to do in the future, we look at fundamental measures of risk, both qualitatively (e.g., sustainable competitive advantages) as well as quantitatively (e.g., size and health of balance sheets, free cash flow characteristics, etc.), to drive our investment process. These measurements of risk paint a much clearer picture of the risk we are taking versus stock price volatility.
I have no problem with this as a strategy so long as investors fully understand what it means. It means you probably shouldn’t buy these funds when markets are doing well but there are clouds on the horizon unless you are willing to stomach some significant losses in the short-term yet continue to hold. It means if you aren’t willing to or can’t stomach short-term losses, you should only buy these funds after they’ve crashed, like now, or nearer to the start of a bull market as opposed to its end.
In other words, these funds will offer little downside protection in bear markets, but likely more upside in bulls. Because volatility isn’t a concern I would expect them to fall as much as the broad market if not more so during downturns because though they invest in high quality businesses, most are small and micro cap businesses. When downturns occur investors tend to sell such tiny illiquid stocks indiscriminately—an opportunity for the long-term investor but terrible for the short-term one.
I agree with what others have said here. What struck me in the letter was another GP mea culpa and that somehow the extreme drops in the funds could have been mitigated in 2022. The solutions, which sound to me like creating more committees, do not make much sense.
There are only a handful of small-cap funds less volatile than the S&P 500, and I don't know if there are any with a growth-stock orientation like these funds. One on the value side is RYSEX. Actually, NBGNX is one on the growth side. But that has a very different style and owns much larger stocks than these GP funds. It doesn't make them bad funds, but you have to know what you're buying before investing. Perhaps it would be a useful launch for GP, given the slew of fund launches they've had over the years, to create a new truly defensive small-cap fund.
A couple of things that make small cap funds more defensive in downturns are cash obviously, put options, holding dividend-paying stocks with a strong track record of paying them, strong balance sheets, low valuation but high quality companies with the aforementioned strong balance sheets. RYSEX for instance holds cash and seeks companies with low valuations and rock solid balance sheets. QRSVX on the value side is similar.
@Derf Only deities and the "universe" provide signs. We're just humble humans not sure where the markets are heading with any certainty. But perhaps the universe is trying to tell us something.
I agree with what others have said here. What struck me in the letter was another GP mea culpa and that somehow the extreme drops in the funds could have been mitigated in 2022. The solutions, which sound to me like creating more committees, do not make much sense.
I own some GISYX and read this letter with a bit of trepidation. It sounds like GP doesn't really come up with fair value for a company before they buy its stock. If they did, they wouldn't need new committees, they'd just have to begin whittling down a position once it reached fair value, something they should have in mind from the start. This apparent shortcoming belies all the verbiage about "world class" systems running through the letter.
I suspect many growth managers do have fair value estimates, but those estimates have to change with interest rates. A stock with a 4% earnings yield today, i.e., a 25 p-e but great growth prospects in the distant future, looks a lot more attractive when interest rates are 0% as opposed to 4%. If you can get 4% guaranteed from T-Bills, that 25 p-e becomes toxic. I don’t think most growth managers are trained to handle this kind of rising rate environment. Admittedly, once rates peak or are near peaking, they should do better—that sign, perhaps, Derf was looking for. The thinking of many growth managers is that high p-e stocks will eventually grow into their valuations, that the p-e only looks inflated today and ignores the tremendous future earnings potential. The problem is investors don’t want to wait around for tomorrow’s growth when they can get a 4% yield on T-Bills today.
Seems to me one of the top managers left on sabbatical a while back. This may have contributed to the amount of loss taken by GP. After being warned about their newest MF I took a toe hold & added a knuckle. My bad, & I'll probably take a loss on that one !
I actually think they’re well-run funds, but, as I said, you need to understand them before buying them. They are more for playing offense than defense. But almost all small cap funds are. Great if you’re feeling bullish. Bearish—not so much.
Comments
Oversea smaller caps tend to get hit harder than the larger caps during drawdown such as 2022. Other than the Contrarian fund, all Grandeur Peak funds are growth-oriented, thus likely to suffer even more.
In other words, these funds will offer little downside protection in bear markets, but likely more upside in bulls. Because volatility isn’t a concern I would expect them to fall as much as the broad market if not more so during downturns because though they invest in high quality businesses, most are small and micro cap businesses. When downturns occur investors tend to sell such tiny illiquid stocks indiscriminately—an opportunity for the long-term investor but terrible for the short-term one.
A couple of things that make small cap funds more defensive in downturns are cash obviously, put options, holding dividend-paying stocks with a strong track record of paying them, strong balance sheets, low valuation but high quality companies with the aforementioned strong balance sheets. RYSEX for instance holds cash and seeks companies with low valuations and rock solid balance sheets. QRSVX on the value side is similar.
Show me a sign, Derf