The figures demonstrated just how complicated 2018 was for asset managers and for alpha generation. Traditional asset managers have always relied on classic company valuation tools for creation of value, favouring the more financially stable of two companies compared, that with a better valuation and a rosier growth outlook.
We strongly believe in this working philosophy and maintain that, whilst it may suffer during certain market phases, it will come out on top in the long term.
Application of these investment principles in the Italian market has led to alpha generation over the years: the winning portfolio was that composed of long stocks on selected large caps capable of significantly outperforming the main list, along with positions on small caps that, providing the asset manager was successful in their selection, permitted large profits. In fact, due to the dimensions of small caps, it is difficult for large caps to match their growth potential.
However, over the last year and a half a paradigm shift has been seen on the markets: for the first time in several years, small caps have underperformed large caps. There are two main reasons for this shift: one is the greater component of automatic and passive instruments in exchanges on stock markets and the other is high valuations. This type of product, that selects stocks on the basis of momentum and therefore requires quick entry and exit from investments, favours the purchase and sale of indices and therefore finds the fundamental characteristic for its investment choices in the liquidity of large caps. Price variations are therefore influenced by the logic of this enormous quantity of flows, particularly during phases of upward movement when the large caps, the only possible target for these instruments, outperform the rest of the market.
What we have seen in 2018 is that the small caps not only underperformed during the initial phase of upward movement, as explained above, but also during the downward phase. In this case, the reason must be identified as the disproportionately high valuations that the segment reached, both globally and nationally (in Italy, the PIR bubble contributed to sometimes unreasonable multiple expansion). Correction of the markets over the last year has however rectified valuations in the small-cap world, also going beyond what was justified. We therefore maintain that, if we face a market reversal, small caps should outperform the stocks on the main list and therefore allow traditional asset managers to create value.
In conclusion, we suggest maintaining exposure on more liquid components, maintaining hedging through put options, whilst continuing to select small caps with good growth prospects.
Interview with Massimo Trabattoni, Head of Italian Equity