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Trends – Institutional Monthly
An auspicious time for Swiss small caps 

13.10.2015

We deem Swiss small caps to be favorably positioned to benefit from the recovery in Europe, with operating leverage, currency sensitivity and a low degree of financial leverage providing additional support. 

Trends – Institutional Monthly

Swiss small caps are currently attractive for a number of reasons. Macroeconomics, exchange rates, the business situation of Swiss companies, the typical characteristics of small caps in general and some peculiarities of the Swiss small cap segment are all pulling in the same direction. In this piece, we aim to shine a light on these factors and show some of the possibilities open to investors in the area.

As part of the local economic landscape, Swiss small caps benefit from the general robustness and reliability of the Swiss system. This includes such well-known factors as institutional and political stability and a largely business-friendly tax system. A high level of training and education in the workforce as well as a tradition of innovation and development are particularly suited to small caps, as many of these nimble companies are in tech-oriented sectors, with access to cutting-edge solutions as a decisive success factor.

Swiss small caps seen benefiting from a recovering European economy
On top of this, the Swiss economy is particularly export-oriented, and Swiss small caps even more so. Where large caps are truly global, often having their production facilities and their markets spread all across the world, small caps tend to be set up more locally. Swiss small caps have more facilities in Switzerland, and their most important markets are in Europe. This puts them economically and geographically in touch with Europe, much more so than for the broader market. As the economy on the continent picks up, we see small caps facing increasing demand from Europe, and think they should particularly benefit from a European recovery.

In addition, owing to lower input costs on the back of still-low raw material prices as well as a high degree of operating leverage, Swiss small caps have the opportunity to fill this demand easily and profitably. In fact, as demand increases, currently unused production capacity can be quickly and cheaply activated. Where investments in increasing capacity become necessary, financing costs are still at record lows on the back of lower spreads and at times even negative benchmark rates.

Cyclical small caps tend to outperform in upmarkets
Being in a recovery phase is significant beyond the growth in Europe – the most important market for many of these companies. Much more generally speaking, small caps have historically been a pro-cyclical investment, outperforming a bull market and underperforming a bear market for many reasons.  

  • Being small, flexible companies, they can operate in segments of the market at the very edge of profitability – hard-hit when things go sour, but with potential to climb sharply in a growth phase.
  • Small companies can be dependent on one or two orders from one or two clients. They have fewer possibilities to spread the risk around the globe. If such an order is canceled, it can mean a significant blow to revenues. But if a new order comes in, the opposite is also true.
  • In addition, many of these small and mid-caps are in the industrials and IT sectors. The cyclical sensitivity of the small cap company and the sector it operates in are complementary.  

Valuations are supportive; currency woes on the back burner
Current valuations of Swiss small caps relative to the broader market are still in the lower part of the historic range, suggesting some upside potential. This comes on the back of surprising resilience shown by the segment during the currency turbulence in the first half of 2015. After the Swiss National Bank (SNB) discontinued maintaining the minimum for the EUR/CHF exchange rate at the beginning of the year, dire warnings were heard from the managements of many small caps as well as from most market observers. However, both stock market performance and the course of business have been above these expectations over the past few months. Recently, the CHF has weakened somewhat from its highs of spring and early summer, which has lent further support to our scenario of European export-led strength in Swiss small caps. Our current currency forecasts call for a further strengthening of the EUR/CHF rate, which would certainly be welco! me. We maintain, however, that Swiss small caps have shown the capacity to withstand adverse currency conditions, as they have impressively shown this year.  

In this issue:

• Investment strategy and asset allocation: High market volatility to persist

• Alternative ideas: Managing the turmoil with alternative strategies

• Food for thought: Swiss Credit Handbook 2015 – key findings

To read the full article download the latest "Trends – Institutional Monthly" (PDF) 

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