In this Q&A, Brad McGill – manager of the newly launched Aperture Discover Equity fund, a US small-cap strategy – explains how he and his team discover the best of tomorrow’s corporate leaders by identifying transformational change.
Why should an investor consider Aperture Investors SICAV - Discover Equity Fund over a typical US small cap fund?
There are a few things that make us a bit different. I’ve spent over 15 years specialising in small cap stocks and have found that a very selective, concentrated strategy can be advantageous for investors. At Aperture, we limit our capacity to preserve the opportunity set for investors and prioritize alpha generation, as opposed to some competitors with many positions and several billion-dollar AUM small cap strategies. Secondly, we have a very clear set of time-tested investment criteria that we follow with a lot of discipline. Thirdly, we have a long-term time horizon and invest for 2-4 years on average. We don’t run a coverage model and don’t aim to have an opinion on every stock in the investable universe. Instead, we focus on a small, high conviction basket of ideas that we believe can appreciate over 50% or more over a two-year period. These features, in my view, create a differentiated portfolio compared to many of our peers.
The fund typically holds 20-30 stocks, and up to 15 short positions. How do you manage concentration risk?
We adhere to strict risk guidelines. For every position, we create upside targets and downside risk thresholds. We target a minimum of 50% upside and every stock has a 3-1 asymmetry in terms of upside relative to downside. We pair these guidelines with our very clear investment criteria set. We continually review the key drivers and milestones of companies to assess if our thesis tracks our expectations and criteria. Position sizing is determined by confidence levels and our expected range of outcomes. At the portfolio level, we consider beta-adjusted exposure by sector and position, volatility, and other risk factors.
Given the nature of small cap stocks being under- researched, how do you identify which companies are worth investing in and conversely, which ones to short?
We have a very clear sourcing process designed to consistently identify competitive companies that we believe are undergoing positive transformational change. As a small team, we turn the traditional sector coverage model on its head. We look for unique companies within sectors and indeed our portfolio does not mirror the benchmark.
Our investable universe includes over 2,000 US small caps, but we narrow this down and focus on about 300 a year to find the seven to ten ‘best ideas’ that we find compelling. In terms of shorting, we only short with an aim to generate a positive absolute return for our investors. These ideas typically arise naturally from our investment process, so it could be a company that we previously researched as a long candidate.