The growth component of a global equities portfolio should come from smaller and mid (SMID) cap companies rather than emerging markets, says Bell Asset Management's Ned Bell.
Bell Asset Management has differentiated itself in recent years by focusing on the smallest 30 per cent of the MSCI World index, according to Mr Bell, its chief investment officer.
Mr Bell sat down with InvestorDaily to discuss the driving factor behind Bell AM's impressive 41 per cent returns for the year to July 2015, which outperformed MSCI World by 7.2 per cent.
"We invest in what we call the global 'SMID' [small and mid] cap part of the market," he said.
While the acronym doesn't roll off the tongue, SMID cap companies have proved particularly lucrative for Bell Asset Management – with the sub-sector currently comprising 40 per cent of the manager's global equities portfolio.
"We think SMID is much better alternative to emerging markets for fulfilling the growth component of a portfolio," he said.
"It’s the bottom 30 per cent of the MSCI World Index. That equates to stocks that [are] between US$1 billion and US$28 billion.
"In Australian terms those companies seem huge. But in global terms they’re quite small, and most portfolios don’t have much exposure to them," Mr Bell said.
Traditional small-cap managers are in the US$1 billion to US$12 billion range, he said.
"There’s some terrific companies there but there’s a bit more volatility.
"But if you extend it to SMID, that next 15 per cent up, that’s where we feel a lot of investors don’t have a lot of exposure – and that’s the real sweet spot we’re trying to hone in on," he said.
In the past five years, the earnings growth of SMID-cap companies has been 14.3 per cent compared to 7.2 per cent for MSCI World as a whole, Mr Bell said.
Sales growth for SMID-caps has been 8.9 per cent versus 4.8 per cent for the benchmark in the past five years, he added.
By comparison, earnings growth in emerging markets has been very poor in the past half-decade, Mr Bell said.
"Emerging markets have simply not worked [as an asset class]. Earnings growth in emerging markets is down 10 per cent over five years. That is extraordinary," he said.
"It tells you something about the companies [in emerging markets] too. Given the economic outlook is worse now than it was five years ago, you have to come up with some pretty heroic assumptions to legitimately think the earnings are going to turn around anytime soon.
"We think from an asset allocation perspective investors should be seriously be considering allocating to global SMID as a way of improving your overall growth profile," Mr Bell said.