Market rally has U.S. fund managers eyeing smaller companies

September 14, 2016 4:57 PM EDT

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By David Randall

NEW YORK (Reuters) - With the U.S. stock market near record highs, some mutual fund managers say they are opting to go small, picking up the shares of companies with tiny market values that may have more room to grow.

Companies with smaller market capitalizations are typically seen as riskier because they may not trade as often or have the same financial cushion as larger companies.

Yet fund managers say that these companies look attractive at a time when larger companies struggle to post earnings growth, increasing the likelihood that small companies will become acquisition targets.

Earnings of the companies in the large cap S&P 500 are on pace to decline 2 percent in the second quarter, and 1 percent in the third quarter, according to Thomson Reuters data.

At the same time, the broad rally that has pushed the small-cap Russell 2000 index up approximately 11.5 percent over the last six months means that there are fewer small companies trading at attractive prices, leaving fund managers more willing to dip lower instead.

"We're finding more interesting stories the further we go down in market cap because it's more likely you will find something that's been overlooked," said Mike Balkin, a co-manager of the William Blair Small Cap Growth fund.

Balkin has been adding shares of companies that may be acquisition targets, such as remote control marker Universal Electronics Inc, a $1 billion market cap company that extended its agreement with Comcast Corp in March to provide voice activated remotes for the company's Xfinity cable system.

Shares of Universal Electronics are up 40.2 percent so far this year.

Overall, so-called microcaps have outperformed both small-caps and large caps over the last six months, with the Russell Microcap index gaining 12.6 percent, a 1 percentage point jump over the Russell 2000 and more than double the 5.5 percent gain in the S&P 500 over the same period.

Sandy Villere, a co-portfolio manager of the Villere Balanced fund, said that he is buying smaller companies as more investor money flows into dividend stocks such as telecoms and utilities.

He has been adding shares of Taser International Inc, which makes non-lethal weapons and body cameras used by police departments. Shares of the $1.3 billion market-cap company are up 46 percent for the year to date.

"Money keeps pouring into the big, safe companies, and that's leaving these small growth names there for the picking," he said.

(Reporting by David Randall; Editing by Alan Crosby)

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