Q&A with Neuberger's Brett Reiner on small-cap funds

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Posted: Dec 29, 2016 3:50 PM
Q&A with Neuberger's Brett Reiner on small-cap funds

Small-company stocks are enjoying a heyday.

They've been one of the big winners in the post-election stock market rally, largely due to the belief that they are poised to benefit more than other companies from President-elect Donald Trump's proposed policies.

We spoke with Brett Reiner, a managing director and associate portfolio manager at the Neuberger Berman Genesis fund, about this recent run-up. He is part of the nine-person team behind the fund, which focuses on "boring but high-quality businesses" in the small cap market, essentially those with high cash flow, good return on capital and conservative balance sheets. Answers have been edited for length and clarity.

Q. Can you explain why there's been this run-up in the stocks of small and mid-sized companies?

A. Just to give you some numbers, since the election the Russell 2000 is up about 15 percent. That compares to the S&P 500 being up about 6 percent. All the outperformance has occurred since the election.

That is the case for a few reasons. I think there's a view by the market, including us, that President-elect Trump's policies are pro-U.S. and pro-growth, so that is particularly beneficial.

Small companies derive more of their revenue and profit from the U.S. and they have meaningfully higher tax rates because of their focus on American revenue. So any change in tax policy will have disproportionately greater impact. Also there is talk of simplifying regulatory systems and smaller companies have had a tougher time navigating through the regulatory issues because of their size and scale.

Q. Are the assumptions in the marketplace about small companies correct?

A. Small cap companies should be the best positioned to benefit from these polices, while being less exposed to risks of protectionism. That is critical to understand.

When investors talk about valuations relative to S&P, which are relatively high, they haven't adjusted for what are assumed to be the change in tax rates ahead. When you adjust, which is a leap of faith but not much, if you adjust for what is the likely tax rates the Russell 2000 is not trading at such a premium.

One thing we get asked about a lot is about interest rates. Clearly there would be an impact on all companies that have debt. For our portfolio, we have companies that have conservative balance sheets, so we think our portfolio would benefit from higher rates. Higher interest rates should have a minimal impact on our companies' earnings.

Another aspect that is important to remember is that higher rates will make it easier for our companies to make attractive acquisitions. Some of our companies who have been chomping at the bit will be able to do so more easily. This might crowd out financial buyers that have been buying up assets.

Q. Is it dumb for someone who has been watching this run-up to jump in now?

A. We think at the current time there's a disconnect between what the market has done and current performance.

The market is anticipating positive change, but companies are still performing under the current environment, where change hasn't occurred.

So it is possible that when they start to report their full 2016 results, or maybe provide 2017 guidance, this will not reflect whatever positive change that will occur. So there could be some point in the next couple of months there could be that disconnect.

What has been discussed in terms of the President-elect's policies should be powerful and should become evident in 2017, but there's this transition period that could be interesting in terms of what investors expect to occur.

Q. Is there anything else investors should know?

A. We think investors should closely monitor what the president elect and the Republican Congress are saying. While it's hard to predict the future, what is being discussed is not modest change, it could be meaningful change and that is what the market is reacting to.

The market would not be reacting this way if Hillary Clinton would have become president because that would have been more incremental or gradual change. What's being discussed now is really transformational change, change that will lead to a very different business environment.

That is why you are seeing gains in the market and why the market is picking winners and losers in terms of sectors.