MicroCap is Always Full of Opportunity…and Risk: Q&A with Travis Prentice, CEO and CIO of EAM Investors
[Originally published in the Planet MicroCap Review Magazine Summer 2023 Issue]
1. Reflecting on the first half of 2023, what trends have emerged in the world of MicroCap stocks, and how have they influenced the investment landscape?
The investment landscape was heavily influenced by macro events in what was a volatile first half of 2023. January started off on a strong note; a bit of a relief rally from a challenging 2022 across many sectors. However, the strength was concentrated in stocks that had underperformed meaningfully in the prior year and those with the highest BETAs. January’s market dynamics had all the hallmarks of a classic momentum crash. In fact, by our calculation, January was the 10th worst month going back to the late 1920’s for the momentum factor in US equities and the 17th worst in Non-US equities since the early 1990’s.
Despite the volatility, we have still been able to find meaningful trends. One of the more surprising sources of momentum in the US has been homebuilders and building supply companies - not an area that you would necessarily expect to be strong given higher interest rates and the banking crisis in March. Nevertheless, we are seeing better than expected performance and some green shoots of recovery in those industries. We have also seen momentum in biotech within US micro cap, especially those related to breakthroughs in oncology and liver disease. Of course, more recently we are seeing emerging trends and trends that were in place accelerating in all things related to AI.
No matter what might be happening in the world economically, we have found over the years that there are always companies doing well somewhere. Our systematic application of momentum investing allows us to find them, unbiased to the source of strength.
2. Can you highlight potential opportunities, risks, and key factors to consider when investing in MicroCap stocks in 2023 thus far?
Micro cap is always full of opportunity….and risk. Overall, we think it might be a good time to invest in micro cap overall given its recent historic underperformance relative to larger market caps and tough sledding overall. We believe there could be a good snap-back rally in both absolute and relative terms in an equity market recovery scenario. From a stock specific perspective, we believe there will be massive opportunities for micro cap companies globally to pivot towards the strength in AI. We look at the opportunities from AI in three buckets: 1) enablers – those companies that can provide the building blocks that enable these giant AI workloads from a technology infrastructure perspective and supply innovation to larger companies, 2) integrators – those companies that can integrate the power of AI into their products/services to gain market share going forward, and 3) harnessers – those companies that can implement the power of AI to unlock massive productivity gains and earnings power in their own businesses. We believe micro cap companies globally can play in all three of these areas as it relates to AI.
Lastly, we believe there is opportunity in micro cap globally as supply chains move closer to home. Micro cap companies tend to be more levered to their local economies, so they should disproportionately benefit from manufacturing and consumption originating with a more domestic orientation.
3. How has macro news influenced your current portfolio construction and when assessing new ideas?
From a portfolio construction standpoint, we haven’t changed anything given the macro backdrop. Given micro cap’s general volatility, we have always believed that you need a disciplined approach to risk management and a sufficiently diversified portfolio no matter the market conditions. When assessing new ideas in a volatile, macro-driven market, it is even more important to focus on true alpha signals through the noise. Systematically, our investment process captures those companies with positive momentum in their business and their stock prices. From there, we focus our research on those that have clear rationale for that momentum. We only invest in those companies with clear reasons as to why that momentum may persist long enough to earn value-added returns. We have found that in overly macro-influenced markets, you tend to have a higher proportion of false positives, which is why the combination of momentum and rationale is extremely important.
4. For the rest of 2023, what are some key criteria, macro events, MicroCap events, etc... that you are watching and what actions will you take if those potential occurrences happen?
Our investment approach will stay the same no matter what may happen. We perpetually move our portfolios to strength and away from weakness, to new trends and away from old trends that are breaking down. However, for micro cap in general, we believe the macro economic cycle/path of interest rates will be most important to watch. Historically speaking, micro cap stocks are most sensitive to changes in investor sentiment and economic cycles. Micro cap tends to lead into the downdrafts and lead out in the recoveries. Given the amount of money on the sidelines and the relative lack of liquidity in micro cap versus larger market caps, we think the eventual rally in micro cap may be explosive in a recovery scenario. As we like to say, come to micro cap for the BETA in recoveries, but stay long term for the alpha opportunities.
For more information about Travis Prentice and EAM Investors, please visit: www.eaminvestors.com
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