After a Mighty Move in May, CTSIX Looks Forward to a Market Rotation Toward Small Caps

You might agree that the Calamos Timpani Small Cap Growth Fund (CTSIX) had a pretty good May. The fund:

• Entered the month down -7.59% for the year and, with a 14.92% return, closed May up 6.20%. More than 1200 basis points away in the other direction was CTSIX’s benchmark, the Russell 2000 Growth Index, which finished May down -6.65% for the year.

For context, within Morningstar’s Small Growth category, less than one-third of funds (32%) were positive year to date through 5/31/20.

• Affirmed yet again the team’s ability to pick winners, as analyzed by the team’s internal methodology. The earnings season (remember that small caps report later than large caps) was one of CTSIX’s best, according to Brandon Nelson, Senior Portfolio Manager.

  For the last few years, the team has tracked outlier performance—stocks that had one-day 5%+ moves higher and lower on the first trade day after a stock reports.

  The results last month: In absolute terms, the fund’s outliers were 80.6% positive (29 of 36) and just 19.4% negative (seven of 36). Relative to the benchmark, outliers were 78.4% positive (29 of 37) and just 21.6% negative (eight of 37) for that one-day analysis. Both the absolute and relative positive outlier figures are well above average.

  ”Earnings seasons have tended to be alpha generators, and that’s how it should be,” says Nelson. “That’s when you get a tidal wave of data. When companies are beating estimates, that’s when they enjoy the multiple expansion. It makes sense that you should be generating disproportionate alpha during earnings season because that’s when the datapoints are fresh.”

  As shown below, the CTSIX team has consistently found upside surprise.

  

• The top contributor to CTSIX’s performance was bought multiple times on May 5 for an average price of $10.69 per share. It closed on May 29 at a price of $21.89. The holding, which Nelson can’t name because it has yet to be publicly disclosed, is among the top 15 weights in the fund, and CTSIX owns more than 1% of the company. This “winner” is not in the index. “This is why you would own our fund instead of an index,” Nelson says.

Small Caps Are Poised to Mean Revert

But as strong as May was, Nelson is even more positive about what he believes is ahead for small caps. With small caps having lagged large caps for the last 3.5 years, Nelson agrees with many strategists who believe the stage is set for a mean reversion for small caps to outperform going forward.

Specifically, Nelson expects small caps to perform what has been their historical role: to lead the market out of recession. The first 12 months of a new bull market following an economic downturn have historically involved significant outperformance—1400 basis points—by small caps. (See this April post from Nelson.) 

The performance of large and small cap stocks has rarely, if ever, been as divergent as it is currently, according to Nelson. The last time it was close—20 years ago—the Russell 2000 reverted to the mean by outperforming the S&P 500 by approximately 50%.

“It doesn't necessarily mean that large caps need to go down a lot in value. They could flatline or only rise modestly from here, and you could see small caps climb significantly more,” said Nelson at last week’s "A Closer Look at Small Cap Opportunities" webcast (watch on-demand here).

Finally, Nelson calls attention to one more market dynamic for those seeking to position their clients for upcoming small cap opportunities.

“Active management in small cap growth always makes sense because the inherent higher volatility of the asset class creates so many opportunities to outperform,” he says. (Indeed, investment professional respondents to Calamos research last year agreed—two-thirds said they were likelier to choose an active manager for a small cap fund.)

But the active management edge is particularly evident in markets like these when dispersion (range of performance between stocks) is as high as it’s been this year. As shown in the chart below, dispersion is highest in small cap growth at all times but “off the charts” this year.

Investment professionals, reach out to your Calamos Investment Consultant to learn more about why we’re enthusiastic about CTSIX’s prospects. You can reach him or her at 888-571-2567 or caminfo@calamos.com.