In the latest Meet the Manager profile, Money Management speaks with Christopher Chen of American Century Investments.
Chen is a senior investment director, Asia-Pacific, based in Hong Kong, and has worked at the firm since July 2018. Prior to this, he worked as a client portfolio manager at Barings and Mirae Asset Global Investments.
American Century Investments is a US asset manager with US$230 billion in client assets.
Chen will be speaking at the upcoming Australian Wealth Management Summit to be held in Sydney on 8 May.
Read on as Chen discusses the performance of small caps and the firm’s approach to stock selection.
Money Management (MM): How have global small caps performed over the last few years?
Christopher Chen (CC): Global small caps have really underperformed. One of the key issues has been the sharp rise in interest rates and bond yields, and that was a key headwind against small caps. At the same time, we have had very concentrated outperformance in large-cap, tech-related stocks so the performance gap between large and small caps is very wide.
We’re looking at an opportunity here where it is pretty clear that rates have peaked, inflation and bond yields have peaked, and the headwinds against small caps over the last couple of years have gone away and that can become a tailwind. The stars are aligning for small caps which is why we think it’s pretty exciting.
MM: Are there specific sectors you favour?
CC: Over a quarter of small caps are not profitable if we look at the US market, so it is very important to be selective. We look at investing through the lens of earnings acceleration where we want to find companies with a positive inflection in fundamentals, and this approach works especially well in small caps. It’s such a target-rich universe that we can really apply that approach and take a very pure application of the investment approach.
Artificial intelligence (AI) has been a big focus and there are reasons to be excited by AI, beyond the usual suspects like Microsoft and Nvidia. We think there are attractive opportunities in niche small-cap areas; some areas we like are thermal management within data centres, hardware, chip design and supply chain management.
MM: Are there any small-cap stocks you can see as being the “next big ones” in the future?
CC: There’s been good examples in the small-cap space of companies which have gone way beyond being small caps, and we certainly do want to see those serial compounders in the portfolio when we look at a theme such as AI. But then we also want companies which are improving their efficiencies or launching new products, which are going to give those companies the ability to accelerate over the next one or three years.
MM: What factors drive you to sell a stock? Do you have a target in mind, or is it more market-sensitive?
CC: Selling is almost as important as buying. The market tends to be late to recognising change and tends to extrapolate past trends into the future on both sides of the growth cycle. As we identify exit points, we tend to look for whether there’s a change to our thesis, and we also look for an earnings gap which is our expectations relative to what the street or the consensus expects in terms of estimate. Then we look for valuations against its peers as well as its own history.
So the key pillars we look for would be whether it is still sustainable or not over the period, whether we’re still getting that positive gap between our expectations and the market expectations, as well as whether we have a good risk reward.
MM: What is American Century’s approach to ESG and how does it factor into the investment process?
CC: ESG is very important because sustainability factors clearly have the ability to cause material financial risk or opportunity for our investments. It is imperative for us to factor those in as a prudent and responsible analyst and manager.
When we look at this, we make very clear distinctions between different industries, so your ESG materiality is going to look different at an energy company compared to a software one; it needs to be specific to the certain type of business and be integrated within our financial estimates.
We use external vendors as data providers, but we really try to generate our own views as well and we want to be able to tailor our views on sustainability depending on the type of business we are looking at.
To listen to the full interview with Chris Chen and a range of other experts, you may access the Relative Return podcast here.