A Conversation with Peter Puccetti
This month, we explore the significant shifts in small cap active management over the past two decades with Peter Puccetti, Chairman & CIO of Goodwood Funds. Particular attention is paid to the profound impact of ETFs, which tend to invest heavily in large cap stocks to mirror indices. Smaller companies often struggle to attract the same level of investment, altering traditional valuation metrics and performance expectations within the small cap sector.
What has been a significant change in small cap active management over the last 20+ years? There has been a secular change in small cap active management, particularly due to the growth of ETFs, which crossed over 50% of all pooled capital/mutual funds earlier this year and continues to grow. ETFs predominantly invest in the largest names because they mimic the indices, causing a self-reinforcing outperformance of super large cap names. This outperformance is far greater and longer-lasting than previously experienced.
What impact has the rise of ETFs had on small cap active fund managers? The rise of ETFs has caused small cap active fund managers to dwindle, as the capital they have available to invest is diminishing. consequently, what used to be considered cheap in the small cap market is no longer cheap enough. Despite small cap names reporting decent quarterly numbers and trading at low earnings multiples, their stock often drifts to new lows after an initial pop.
How has the market responded to small cap companies with potential value? When a small cap business has value, a takeover offer often emerges, either from a PE firm or a corporate acquirer. This has been particularly evident in the software space on the TSX. The market's response highlights the challenging environment for investors focused on non-resource small cap companies, where low valuations persist without a takeover offer.
What strategy have you considered to navigate the current small cap market? To navigate the challenging small cap market, I focus on companies that are paying out cash to shareholders through dividends or share buybacks, or where there is clear takeover value above the current share price. Additionally, having influence with the Board is crucial.
What's on your reading list this summer?
“Never Split the Difference”, Chris Voss
“Sapiens”, Yuval Noah Harari
“Principles For Success”, Ray Dalio
“Chaos Kings”, Scott Patterson
“Poor Charlie’s Almanac” (2023 updated edition), Peter Kaufman
