When it comes to ESG, smaller companies have their own unique challenges—which can also provide opportunities for active managers to identify unrecognized growth and undervalued companies.
Following the turbulent events of 2020, smaller capitalization equity markets have rebounded markedly. There are indeed a range of reasons for this recovery, from optimism around progress in vaccination programs to economic re-openings to ongoing support from governments. In particular, highly cyclical sectors that were heavily impacted by the lockdowns—such as commodities, mining and energy—have led the recovery. While quality companies with good growth prospects have more recently regained momentum, fundamental factors, including environmental, social and governance (ESG) considerations, have in some cases taken a back seat to cyclical growth as the economy has re-opened.
In our view, this set of circumstances has created a compelling opportunity for long-term, fundamental investors to uncover unrecognized growth and undervalued companies in the smaller company equity universe. And we believe ESG factors will play a significant role in this—particularly given the increasing regulation and investment focused on climate change mitigation around the world, from the Paris Climate Accord to the EU Green Deal.
A LARGE UNIVERSE OF UNDER-RESEARCHED COMPANIES
With roughly 1,000 companies in the European small-cap index and around 2,300 in the international small-cap index—and many more not included within these standardized benchmarks—there is an abundance of potential investment opportunities. But the size of the investment universe also presents a challenge in terms of coverage—indeed, there tend to be far fewer sell-side analysts covering each stock, and the information and earnings forecasts that are published often focus solely on the shorter term. While this lack of coverage speaks to the challenge of investing in smaller companies more broadly, it also translates into less comprehensive coverage of ESG factors.