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Counsel Views – Episode 15: Kennedy Capital Management’s Alex Mosman

Capitalizing on U.S. small-cap equities

Counsel Views, hosted by Stu Morrow, Chief Investment Strategist, RBC PH&N Investment Counsel, is an audio series aimed at bringing insights to clients from thought leaders and experts across Canada’s leading wealth management firm.

Episode guest: Alex Mosman, CFA: Portfolio Manager, Small-Cap Select and Small-Cap Select SRI strategies

Following their phenomenal run up over the last year, U.S. small-cap equities continue to prove their importance for investors. In this episode of Counsel Views, Stu welcomes St. Louis, Missouri-based Alex Mosman, Portfolio Manager for the Small-Cap Select and Small-Cap Select SRI strategies at Kennedy Capital Management. Their conversation spans the investment process at Kennedy Capital, and the important benefits of including U.S. small-cap equities in clients’ portfolios. Alex also provides his insights and outlook regarding the asset class, and Stu and he discuss important developments that are driving key outcomes in the equity markets today – and will continue to do so well into the future.

Before becoming a Portfolio Manager, Alex was a full-time research analyst covering the information technology sector for over 11 years at Kennedy Capital. He earned his Bachelor of Science degree in business administration with a concentration in finance from St. Louis University.

The Kennedy team has been managing the RBC Private U.S. Small-Cap Equity Pool since 2008, using a labour-intensive, fundamental-based investment process to manage between 45 to 60 small-cap stocks, including a mix of value and growth stocks that they believe generate superior returns on invested capital.

View transcript

Stu Morrow:
Welcome to Counsel Views. I’m your host, Stu Morrow, Chief Investment Strategist at RBC PH&N Investment Counsel.

With me today is Alex Mosman, Portfolio Manager from Kennedy Capital Management. Kennedy Capital Management is headquartered in St. Louis, Missouri, and they manage just over U.S.$4.8 billion in total assets for their clients. The firm has been managing money for clients for over 40 years, with a focus on U.S. small- and mid-cap companies.

The Kennedy team has been managing the RBC Private U.S. Small-Cap Equity Pool since 2008, using a labour-intensive, fundamental-based investment process to manage between 45 to 60 small-cap stocks, including a mix of value and growth stocks that they believe generate superior returns on invested capital.

Alex Mosman is the Portfolio Manager for the Small-Cap Select and Small-Cap Select SRI strategies at Kennedy Capital. He was a full-time research analyst covering the information technology sector for over 11 years at Kennedy Capital and earned his Bachelor of Science degree in business administration with a concentration in finance from St. Louis University.

Hi, Alex. Welcome to Counsel Views. Thanks for joining me today.

Alex Mosman:
Hi, Stu. Thank you so much for the invite. Appreciate it.

Stu Morrow:
It’s great to have you. I thought maybe we could start off by you giving us an overview of your investment process and explaining to us and our clients how you expect to add value through a market cycle.

Alex Mosman:
Absolutely. Happy to.

So, to start, the Select portfolio, it’s all small-cap stocks, and we’re benchmarked against the Russell 2000. And just as you said, we are bottom-up fundamental stock pickers. We don’t really take a macro view, and we don’t try to play economic data points—large economic data points.

Our strategy and philosophy, it really revolves around looking for catalysts or change in all of our new investments. And these are catalysts that can accelerate revenue, improve margins, and this is driven by new products, new markets, even new management teams. And we want these to be durable changes, events that can impact the long-term for our investments.

And while we hold these investments, as our catalysts play out, we get a chance to watch the companies’ execution and really learn that even more in depth, the industry, competitive advantages, potential threats, management’s ability to reinvest and stay focused on their core competencies.

And many of our holdings have proven, during that time of watching the catalysts get executed, to be excellent at reinvesting in themselves and generating superior returns. And these investments do turn into long-term holdings. We call them steady compounders and we have many in the portfolio. It’s probably 40% to 50%. And these names that—there are names that don’t execute on their catalysts or names that do but don’t really have great long-term fundamentals, and those are sold out of the portfolio.

Of course, what an investment is being valued at in the market also plays a pivotal role in anything that we hold or choose to sell. As you mentioned, we hold between 45 and 60 stocks and we’re relatively concentrated. We usually start a position at 2% and really trim it back if it gets up to 4. And if it gets to 4% of the portfolio, it got there by outperforming.

I should note that we do take smaller positions in riskier sectors such as the biotechnology and pharma sector. And our goal really is to be long-term investors. Our minimum holding period is one to two years; our average weighted holding period is between two and three.

And so, to get to your question about how we add value over a market cycle, the core philosophy, as I mentioned, is to identify change. We’re buying businesses that are getting better. And as the catalysts are playing out, our businesses are improving. So execution on the catalysts should propel the portfolio in flat or up markets.

On the downside, we do have a quality bias—high-returning businesses that have strong balance sheets. We are less levered than the benchmark, and our companies have excellent interest coverage ratios.

The other thing that I think is important to say is that, as a fundamental part of the investment process, anything that makes its way into the portfolio, we’re always asking, what type of business are we owning in the event that the change or catalyst doesn’t get executed as according to plan, which is a way of saying that we don’t want to own poorly positioned investments, if that doesn’t come to fruition.

Stu Morrow:
That’s great, Alex. It sounds like it’s a very robust process.

I’m wondering, has anything at Kennedy Capital or maybe your specific investment process for your funds, has anything changed at all in light of what we’ve been going through in the last 18 months and the pandemic, and the impact that has had on the global economy and the markets as well? Has that been a source of any change for you?

Alex Mosman:
You know, it’s a great question because the pandemic has changed so many aspects of our lives. But I think it’s important that our fundamental process, it has not changed. The philosophy has not changed.

But, we are nimble enough and recognize the change in environment and know the pandemic has changed the tailwinds or headwinds for individual companies. It’s a situation where, when that environment is changing, you absolutely have to be open to it, always learning, always reacting to the newest set of information.

So for example, digitization. The pandemic accelerated the growth rates. These are usually companies that had pretty spectacular growth rates to begin with. Well, this just accelerated everything. There’s no change in the fundamental thesis or the fundamental catalyst of most of these investments that we have, but the growth has been accelerated. And since we’re not tied to price targets because we are always taking into account the newest information, these ideas weren’t sold out of the portfolio, and they continue to benefit from this ever-changing environment.

Stu Morrow:
It’s good to hear. And as you kind of step away from a shorter-term perspective, although, certainly, for the last 18 months, it’s sort of probably felt like 18 years for all of us as we’ve hunkered down.

But if you take a step back and think about the longer-term picture and some of the longer-term investment themes that run through the market, I’d like to kind of get your views on those investment themes and perhaps how the portfolio’s positioned today.

So I mean, the first one, what seems to be on a lot of minds for people, is—we see it day to day—is this debate around inflation and—or deflation, depending on your point of view and, I guess, your time frame.

But what are your thoughts on sort of the longer-term outlook for inflation or deflation? And how do you think that your portfolio is positioned relative to that?

Alex Mosman:
Absolutely. It’s a great question. I do think near-term inflation, it is a risk. It is. But I do think that there is evidence that the inflation that we’re seeing today is a bit more transitory in nature. Yes, the pandemic did distort supply chains. It distorted demand patterns; more physical goods in demand instead of services.

But there is an offsetting item that makes this one different. Yes, we’ve had massive amounts of monetary stimulus. But in the United States, we’ve seen unprecedented amount of fiscal stimulus as well, and this is clearly having an impact on demand. We’ve seen reports that U.S. inflation metrics outpace many developed nations that have also seen their central banks help out.

And so to me, this does lend some credit to our inflationary environment being driven by some of the fiscal stimulus that we’ve seen, which, seemingly, in the current state of U.S. politics, doesn’t seem like this will repeat.

And obviously, there are deflationary trends, technology and automation being some of the most prevalent. But I think those are not so strong as to lead to overall deflation around the world.

As for the portfolio, we’re fairly balanced with our exposure to companies that are economically cyclical versus more steady compounders versus the bench. And that’s really driven by where we’re finding our ideas.

I do think it’s important to state, though, that we always evaluate these risks and potential negatives on a stock-by-stock basis. So some of our more cyclical names, we make sure they have very strong pricing power in their end markets.

Stu Morrow:
Great, Alex. And so, you would take the view in the portfolio that you somewhat diversified, I guess, between a near-term inflation outlook and potential for any longer-term deflation or potential inflation over the longer-term? Is that fair?

Alex Mosman:
Yes. I think we try to be cognizant of the near-term. But over the longer-term, I don’t think either inflation or deflation is going to be so outsized as to create real headwinds or tailwinds.

Stu Morrow:
Gotcha. And you touched on digitization and acceleration of that theme, which was the second theme I wanted to sort of talk to you about and get your perspective on there. And especially given your background as being a research analyst for over 11 years at Kennedy, covering information technology, it’s a great segue to this.

And sort of the broader themes around technology, so AI, even E-commerce, electrification of the car, potentially blockchain, can you speak to those longer-term themes and what your view would be around growth potential in some of those? And then again, maybe towards the end, maybe relate it back to the portfolio, what sort of exposures you would have to any of those themes today.

Alex Mosman:
Absolutely. If there is one theme that’s present in my mind when we look through all of our potential investments and current investments, it would be this adoption of various technologies. Big inflections are happening. And this can be a very positive driver, but it can also be an area of risk. And we are bottoms up, and I think it’s important to state that technology can often be one of the key tenets of our catalysts and can actually drive the investment thesis across the time frame of the holding.

And we’re not seeing this technology change just happen in the tech sector. This is touching every industry. I spoke about digitization earlier and, but we also see it in automation, industrial companies helping their clients become more automated. We even see it in our health care investments—automation, tracking systems—it reduces error rates in patient populations.

And there are certain technologies where the long-term demand is so strong that it can overcome any near-term choppiness that an individual company might have, which makes them such attractive themes.

I should state that, since we are focused on small-cap companies, sometimes our investments are not the primary corporations delivering the end technology, but many times they will feed into it.

For example, electric vehicles. No small-cap company right now is making electric vehicles at any type of scale, but we have many companies that will feed into that supply chain. And I think it’s looking at every company individually that really helps us get to this idea of catalyst and change and execution.

For how the portfolio is positioned, like I said, I do think many of our new investments and investments that have stayed in the portfolio do have a very sizable part of their catalyst driven by execution. I can think of several across consumer, health care, industrials, and obviously, information technology, even the energy sector, that are driven by that.

Stu Morrow:
Thanks, Alex. And maybe we could maybe just touch on one more kind of longer-term theme. So I know maybe this plays well into the small-cap space where you manage.

This idea of localization versus globalization, a change in sort of global supply chains. Some people have dubbed this the manufacturing renaissance, so bringing back on shore some of those activities in the supply chain that were outsourced for the last few decades and the idea of bringing it back onto U.S. shore.

What do you think about that? And in the small-cap space, do you have any sort of exposure to that theme?

Alex Mosman:
Absolutely. It’s another very good one. There’s no doubt that U.S. and Chinese relationship is more strained than it has been in the past, and that has obviously had an effect on supply chains and where companies are willing to invest. We’ve even seen companies pull all of their manufacturing out of China. Now interestingly, that doesn’t necessarily lead it back to North America but there is obvious concern about a lack in diversification in a company’s supply chain.

So in the small-cap space, there are several industries that benefit. Many of the industrial companies, while some component parts are outsourced, there’s still a lot of manufacturing done inside the U.S., especially in the Midwest. And they’re definitely seeing demand and basically getting a competitive advantage due to the fact that they add supply chain diversification for their larger customers.

Stu Morrow:
Interesting. It seems like it’s a theme that’s going to be playing out maybe potentially over the next few years. Would you agree?

Alex Mosman:
Yes. I think this is something that it’s a long-term view for many of these companies. It’s not easy to shift supply chains.

And the other thing that we’re seeing is there’s many—I think we’re going to see governments encourage and even subsidize some of these moves to make sure that especially important economic industries are supported in this. And we’ve even seen talk that the U.S. government will help move semiconductor manufacturing back to the United States.

Stu Morrow:

Alex Mosman:
And this was just change—it just changes the whole dynamic, especially if you’re willing to throw government money at it to help supplant that.

Stu Morrow:
Definitely. Definitely. Well, Alex, we’ve covered quite a bit of ground in a short period of time, and I really want to thank you for taking the time to speak with me today and to our clients at RBC PH&N Investment Counsel. I wish you well and look forward to having you back on the podcast in the future.

Alex Mosman:
Excellent. Thank you so much, Stu. I really appreciate the chance to talk to everybody.

Stu Morrow:
Anytime. Thanks, Alex. Take care.

Alex Mosman:
Excellent. Thank you.


This recording was made on September 21, 2021.

This has been provided by RBC Phillips, Hager & North Investment Counsel Inc. (RBC PH&N IC). All opinions and estimates contained in this document constitute RBC PH&N IC and Kennedy Capital Management Inc.’s judgments as of the date of this report, are subject to change without notice. This report is not an offer to sell or a solicitation of an offer to buy any securities. Persons, opinions or publications quoted do not necessarily represent the corporate opinion of RBC PH&N IC. This information is not investment, tax or legal advice and should only be used in conjunction with a discussion with your RBC PH&N IC Investment Counsellor, qualified tax and legal advisors respectively. Information obtained from third parties is believed to be reliable but neither RBC PH&N IC nor any of its affiliates assume responsibility for any errors or omissions or for any loss or damage suffered.

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