Recent months have seen a reversal of the outperformance in large caps versus small caps from the last few years. We have been calling for this and believe we are still in the very early days of this rotation.
Going into 2021, we expect more of the same from markets, that is, very significant volatility and a bifurcated stock market for small caps. This scenario will continue to drive a wedge between the durable high-returning business models we covet, and companies with low returns on capital and high leverage who could suffer if we don't see a rapidly improved economic and health environment early in the year.
As bottom-up investors, our team does not try to predict the future, but we are always trying to be prepared for the worst. A big reason for the resilient performance in 2020 across our small-cap strategies was simply that we didn't have any major negative impairments in the portfolio, which gave us more time to hunt for opportunity.
We already have our shopping list for 2021 and are meeting with about 100 companies a quarter to make sure we are keeping up to date on the businesses we own and finding ideas that are better than what we own today. This was our approach entering 2020 and it served us well.
We have long said volatility creates opportunity and we have been capitalizing on that volatility when it presents for close to 10 years. This is one of the foundational elements of our investment approach – be prepared to act.
From a positioning standpoint, we are underweight materials, energy, utilities, cyclical financials, and industrials and real estate where we think the risk reward isn't attractive, generally speaking. We are very open to the idea that travel and economies will open (permanently) in 2021, but we are being very disciplined in owning companies that will do well even if we are wrong on the timing. Companies like Middleby Corp., Revolve Group Inc. and Stitch Fix Inc. should see improving fundamentals in 2021.
We still have healthy weights in some companies we expect will prove in 2021 that they were more than “stay/work-at-home” beneficiaries. Companies like Breville Group Ltd., who make innovative small home appliances, Ambu A/S, who sell single-use scopes that help prevent patient contamination in endoscopy procedures, and Etsy Inc. may not see the momentum in their underlying growth. However, we believe these companies will compound their revenue at 10-15% for the next decade and remain strong long- term compounders.
Source: CI Global Asset Management as at December 23, 2020.
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