Unlocking Potential in US Smaller Companies
This special edition of the Omnis Investment Club podcast features a discussion with Jonathan Coleman, Portfolio Manager at Janus Henderson, about investing in US Smaller Companies. Coleman explains that this sector, defined by the Russell 2500 index, includes companies with market capitalizations ranging from $100 million to $15-16 billion, which are often larger than what might be considered small-cap in the UK. He highlights the dynamism and entrepreneurial spirit of the US market and shares examples like Wendy's and Euronet to illustrate the types of companies they invest in.
Coleman emphasises Janus Henderson's experienced team, their defined approach using patterns of success, and their long-term investment perspective. He also discusses the current market trends, such as the potential impact of US politics and interest rates, and why US Smaller Companies might be an attractive addition to a diversified portfolio. He points to historical cycles of small-cap outperformance, concentration risk in large caps, and attractive relative valuations as key reasons for considering this sector.
Omnis Investment Club Podcast:
Special Edition - US Smaller Companies with Janus Henderson
Rohit Vaswani (Investment Director, Omnis Investments): Welcome to a special edition of the Omnis Investment Club podcast! I'm Rohit Vaswani. Today, we're featuring Janus Henderson, the new manager of our US Smaller Companies fund. Janus Henderson is a global asset manager with approximately £300 billion under management. We're delighted to have Portfolio Manager Jonathan Coleman and his team making investment decisions for this fund. And, incredibly, Jonathan has joined us in our London office today all the way from Denver! Welcome, Jonathan.
Jonathan Coleman (Portfolio Manager, Janus Henderson): Thanks, great to be here.
Rohit: Let's start with definitions. What exactly do we mean by "US Smaller Companies"? What size companies are we talking about?
Jonathan: The US market is vast. We define our universe as the constituents of the Russell 2500 index, ranging from a US$100 million market capitalization to around US$15-16 billion. This is quite large compared to what might be classified as smaller companies in the UK. Many of our small companies would be considered mid-caps in the UK.
Rohit: To bring it to life, what are some examples of companies we might have heard of?
Jonathan: Two examples: Wendy's, the fast-food hamburger chain known for fresh beef. They differentiate themselves from competitors like McDonald's and Burger King, which use frozen beef. Wendy's has growth opportunities, including expanding outside the US. Another example is Euronet, which provides ATM networks in tourist hotspots across Europe.
Rohit: With the rise of digital payments, do you still see growth potential for Euronet?
Jonathan: Yes, we do. While some worry about the decline of cash, we believe there's a long runway for cash usage. Euronet is also investing in digital wallets and digital payments, so they're adapting to the changing landscape.
Rohit: Jonathan, you've been investing in smaller companies for decades. What makes this part of the market so special?
Jonathan: I've been fortunate to focus on the small and mid-cap space for 31 years. What I love is the incredible dynamism of the market. The US has a very entrepreneurial economy. We often meet individuals who defied the odds and made their ideas work. It's energizing to meet these entrepreneurs.
Rohit: What key attributes do you and your team bring to the table?
Jonathan: We have a dedicated and experienced team that has worked together for a long time – an average of 15 years. We have a defined approach, categorizing patterns of success we've observed over time. We have about 25 of these patterns that have led to successful investment results across sectors. This helps us be efficient with our time in researching the 2,500 companies in our universe. We also have a long-term perspective. Our average holding period is over five years. We believe time horizon arbitrage is a significant competitive advantage. Many investors are too focused on the next 90-180 days and miss the bigger picture.
Rohit: That aligns with our funds, where we encourage investors to have at least a five-year horizon. Can you share an example of one of your patterns?
Jonathan: One pattern we love is an "underappreciated transition." This ties into the short-term vs. long-term view. Often, a company may be investing for the future, with benefits three to five years down the road, but the market isn't giving them credit for it in the short term. An example is Stride Education, an online educational platform. They identified the rising cost of university in the US and started offering career education opportunities in secondary school, allowing students to specialize earlier and earn college credit, thus completing university quicker and at a lower cost. This resonated with the market, and their career education enrollment growth has accelerated. It's a long-term trend, not just a focus on the next 12 months.
Rohit: How might current US politics change the sorts of companies you look to invest in?
Jonathan: We always have to be aware of headlines and potential uncertainty. For example, early approaches to tariffs can create market reactions. We also look at areas like government contracting. While some companies may be negatively impacted in the short term, we focus on the fundamentals and whether they are actually saving the government money. We talk to management teams and do deep research. Sometimes, we just have to prepare for a bumpy ride.
Rohit: What other trends are you hearing from management teams?
Jonathan: After the election, every CEO and CFO we spoke to said they would pass on tariffs. This shows it would be inflationary. We also believe we're in a higher-for-longer interest rate environment in the US. We focus on companies with high returns on capital and free cash flow. We like that credit is becoming tighter because it reduces poor capital allocation.
Rohit: Why does it make sense to have US Smaller Companies in a diversified portfolio?
Jonathan: It's an exciting time to consider an increased allocation. I believe the coming decade will be a period of small-cap outperformance. Historically, there's an alternating pattern of small-cap vs. large-cap outperformance in 8-14 year cycles, and we're now in the 14th year of small-cap underperformance. Second, we're seeing extreme crowding in a few dominant companies, similar to the early 1970s and late 1990s, which leads to market broadening. Third, the relative valuation of small caps is highly attractive. The relative PE ratio is about 0.8, and historically, from this level, small caps have outperformed large caps significantly over the next five years.
Rohit: To summarize: expectation of small-cap outperformance, concentration risk, and attractive relative valuation. It's crucial to have an active manager like you to identify undervalued companies with long-term potential.
Jonathan: Exactly. With 2,500 companies, it's a very heterogeneous universe. An active, deep fundamental research approach is essential to find the future winners.
Rohit: Thank you, Jonathan. It's been a real pleasure to hear your insights. Thanks to everyone for tuning in. If you have any questions about the fund, please speak to your financial advisor.
Find out more about the Omnis US Smaller Companies Fund
