Trends Watch: Small- and Micro-Cap Equity Investing
March 16, 2023
By Elana Margulies-Snyderman
EisnerAmper's Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.
This week, Elana talks with Hunter Frey, Partner, Dharma Capital Advisors.
What is your outlook for investing in small- and micro-cap equities?
Small- and micro-cap equities appear to trade at valuation levels not seen since the late 1990s, potentially displaying a structural opportunity relative to their large-cap counterparts. We believe that focusing on companies with healthy economic margins, non-levered core cash flows and efficient capital allocation/management (especially costs of capital) remains pivotal in identifying alpha among small- and micro-cap equities amid the pending recession, higher inflation and tighter monetary policy. Thus, we perceive that micro/small-cap equities (specifically small-cap value) may provide relative outperformance in 2023.
What are the greatest opportunities you see and why?
We believe private credit and special situation structured equity within domestic markets may present the most significant uncorrelated opportunities. Additionally, our view is that U.S. small caps and micro-cap equities within health care and diversified technology appear to have better-risk-adjusted return metrics than broader equity markets. Furthermore, distressed debt and private credit (from the lending/investment perspective) may remain attractive as traditional lending avenues dry up amid tighter monetary policy and Silicon Valley Bank headwinds.
What are the greatest challenges you face and why?
The greatest challenge we perceive is the planning and capital management of balance sheets amid a pending recession, tighter monetary policy and structurally higher target inflation. Higher terminal rates have structurally increased the cost of capital, potentially causing operational slowdowns, earnings weakness and financing instability (possibly causing private equity/credit to inherit a higher-risk threshold).
What keeps you up at night?
We stay up at night knowing that public markets have a personality and behavioral makeup outside trading hours that directly or indirectly impact performance dynamics. Additionally, due to this idea, knowing that private markets are a rolling endeavor to actively generate alpha/internal rate of return (IRR) keeps us busy into the late hours of the night.
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