Talking Heads – Europäische Small Caps übertreffen Large Caps

This is an audio transcript of the Talking Heads podcast episode European small caps to outdo large caps

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing European small-cap stocks. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Mathieu Bernard, Portfolio Manager. Welcome and thanks for joining me.

Mathieu Bernard: Daniel, thanks for your invitation.

DM: When we think about the outlook for European small caps, the ECB has already made several cuts and markets are certainly looking for more in the quarters ahead. As a portfolio manager, when you think about that monetary policy backdrop, what implications do you see for European small-cap stocks?

MB: The recent rate cuts by the US Federal Reserve and ECB could help European small caps to sustainably outperform, especially versus large caps. Indeed, with [small caps’ greater] exposure to real estate and smaller exposure to financials versus European large caps, small caps’ relative performance could benefit from decreasing interest rates.

It is important to bear in mind that European small caps area higher beta equity vehicle on the region’s economy compared to large caps, with exposure to industrials and materials and a lower exposure to consumer staples and healthcare versus large caps. So, if white goods were to contribute to an economic recovery or expansion, it would probably support the performance of European small caps.

DM: Many of us have been taught that, over the long run, small-cap stocks are supposed to outperform large caps. But in the US, that hasn’t been the case as often as one might like. A lot of that comes down to the dominance in recent years of large-cap tech stocks. In Europe, the picture is different. Historically, you have had long periods of outperformance of European small-cap stocks. What’s your current view on the asset class?

MB: There are a number of catalysts, for example, earnings per share growth. The earnings per share growth expected by analysts for next year is stronger for European small caps than for European large caps – 15% EPS growth for the MSCI Europe Small Caps index versus 11% for the MSCI Europe index, while at the same time, European small caps [are trading] at a 10% discount to large caps.

Another catalyst favourable to European small caps has to do with the overall quality of the balance sheets. The percentage of significantly leveraged companies tends to be lower in the European small cap universe than that of large caps. This should give room for higher capital returns to shareholders, dividend growth, and/or share buybacks.

Also important is the potential for mergers and acquisitions, when a larger group chases growth opportunities among smaller companies. The European small-cap universe has frequently benefited from premium price take-overs by private equity firms or larger listed companies since the beginning of the year.

There has been a clear acceleration [of this over a] number of years. If we focus on the MSCI Europe Small Cap index, after the first nine months of the year, there are 33 ongoing M&A transactions – fully paid in cash two-thirds of the time – across all sectors.

Finally, one should not forget that European small-cap performance is impacted by flows. The asset class’s performance suffered from significant outflows in 2022 and 2023, but inflows have resumed in 2024.

DM: Looking beyond the macro factors, you’re picking stocks. Are there any sectors or industries that you’re particularly excited about these days?

MB: One sector we continue to find compelling is real estate. This is a segment that has been under significant pressures post-Covid, with higher interest rates and uncertainty regarding financing.

However, with the ECB now easing and thanks to attractive valuations, since most European real estate companies are trading below net asset value, we do see material scope for a re-rating.

We continue to find attractive companies in the industrial sector, notably companies exposed to electrification due to the significant growth potential driven by energy transition trends, and those companies enjoying high cash flow generation and the potential for bolder acquisitions. We therefore have a positive outlook on this segment as well.

DM: Mathieu, thank you very much for joining me.

MB: Thank you, Daniel.