Host: So just sort of the broad. And welcome back. So today's capital market segment is brought to you by Alpaca. Now, the Russell 2000 is entering a technical correction last week, but it has rebounded by close to 2% over the past five trading days. So our next guest says standard institutional practices and mandate constrictions in adversity dragged down by alpha generation in small cap equities. So joining me now to expand on this and break down the opportunities in small caps is Chris Tessen, founder and managing partner at Acuities Investments. Chris, thanks so much for being with us today.
Chris Tessen: Yeah, thanks for having me.
Host: All right, Chris, so let's go ahead and kick off, uh, with the, the simple question of, uh, with big institutions and how big institutions invest. Uh, your research, uh, says that large investors like pensions and endowments may be hurting their own returns, so they keep money managers on a short lease and they tend to pick up the biggest firms. So walk us through, uh, what that and does playing it safe actually end up costing them more?
Chris Tessen: I think so. I think part of the challenge is people tend to follow the herd and and go with what works and uh there's no question that we've been in this very long large cap cycle. Small cap hasn't performed as well. We're going on 1315 years of large cap leadership and so we've seen a pretty dramatic swing this year and a lot of, a lot of plans, a lot of, uh, investors are underway to space, um, and I think they're waking up to both the earnings potential of it and the valuation, uh, attractiveness of small cap and micro cap.
Host: All right, so, um, how does your multi-manager, uh, agri, uh, system that you guys have, how does the active multi-manager ETF structure specifically prevent managers from falling into this, uh, capacity traps or, or closet index behavior? Uh, walk us through that.
Chris Tessen: Well, what we do is we evaluate investment managers and put them together in multi-manager structures that allows us to focus on managers where we think. They have the greatest alpha potential and down in small and microcap is the area that we uniquely focus in, but you get to balance these things so you can take managers with concentrated bets that are really seeking best ideas and pair them together into a more sort of broad risk controlled structure that's all weather and then upgrade it consistently so it's sort of an evergreen structure for investors.
Host: All right, so I want to talk. Active management and the higher for longer rate environment. Now passive benchmarks like the Russell 2000, they dragged down by overall return figures because they hold non-earners and unprofitable growth names. So is the active advantage in today's rate climate driven mostly by avoiding the bad companies or by finding fundamental compounders?
Chris Tessen: That's a great question. There's actually a return advantage to avoiding the junk down in small and microcap. So if you actually throw out, unlike large cap, where a lot of companies are financed by debt and that's how they generate their growth, down in microcap and small cap, you know, greater debt might be a step closer to bankruptcy. Non-earners may be a sign that the company is less likely to make it, and there's a preponderance of non-earners down there. So owning the Companies having this active management bent is a true benefit down in small and micro capital.
Host: So I want to kind of shift gears and talk a little bit more about small company stocks. You've called them coiled springs, so they're cheap being compared to big stocks, and their profits are expected to grow about 30%, give or take. So being cheap hasn't been enough to pull investors away from. The big tech. So what will finally get small caps moving from what you've been seeing?
Chris Tessen: Yes, it's really an earnings story and it's happened a bit under the hood. I mean, small and microcap are leading the major indices this year, but going forward you have better earnings prospects down in small and microcap than you do in large cap, and I think that's really core to the story. It's an earnings story. And you take active investment along with that. Active investors have really shown their mettle recently, especially with the Fed hikes, especially with rising interest rates. When there's a bit of a pullback in the market, that's when active management truly shines, not when just folks are chasing momentum of what works.
Host: So Chris, I want to kind of start honing in. Let's talk geopolitical friction, inflation, and rates, because obviously those things are top. Mind. So you know with the trade fights we're talking oil prices, we're talking inflation, and that keeps central banks from cutting rates. So smaller companies usually carry more debt and do most of their businesses they do it in mostly one country, give or take. So if rates stay high because of these ongoing tensions, how much longer can smog caps wait to have their turn to lead?
Chris Tessen: Yeah, I think this pullback is sort of healthy in a way. It's sort of a healthy pairing when the Fed raised rates, small cap sort of took it on the chin, but you have to remember it was up dramatically. I mean, you're talking about microcap stocks since April last year, up 90%, small cap stocks up sort of 60% range, so. It is true in the early days of rising rates it's impactful because it's sort of this risk off event um and people tend to pare back or uh pull back some of their more aggressive trades but over time higher rates don't necessarily mean that small cap is going to lag I think we're. Have a lot of catalysts in place for a much longer cycle for small cap, and it really comes down to both the earnings, which are expected to be higher, and the valuations, which are dramatically lower than large cap.
Host: And Chris, to wrap up, I want to talk a little bit more about manager due diligence and kind of want to look under the hood. So when you combine several specialist managers in one fund, how do you make sure that they're not buying the same stock? Canceling each other out and how do you keep fees low for investors while they're still paying managers enough to do their best work?
Chris Tessen: Yes, well, it's incumbent on us to find managers early, often when they have a low asset base, because that's when we think the earning prospects are the greatest or the active management prospects are the greatest implementation efficiencies in the early days when they have low asset bases, so we Put these managers together and aggregate the structure and use them in various substyles so they're not tend, uh, they don't tend to be overlapping. They tend to be sort of unique animals and it's about understanding them in the at the forefront, doing the really deep in-depth due diligence on the managers in the early days so you know how to put them together and what characteristics they bring to the table so that they don't overlap. So you managers across the style spectrum. And various substyles as well in order to have very little overlap. And when there is a rare overlap, often it can be a positive signal of stock about to get bought or something like that.
Host: Yes, no, it's definitely interesting to see how pretty much all this continues to change and obviously the markets are always ongoing, especially when it comes to this area. So Chris, I want to thank you so much for joining us this morning here on Market Movers.
Chris Tessen: Yes, I really appreciate it. Thanks for having me.
Host: No problem. Thank you.
