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CTSIX Webcast Q&A Offers Deeper Dive into Small Cap Opportunity

Last week’s “Finding Growth in a Low-Growth World” webcast began with Brandon M. Nelson, CFA, challenging the conventional wisdom that 1)the stock market is in a 10-year bull market, and 2)therefore its end must be near.

“The reality is that, for small caps, it’s been a little bit of a bumpier ride. If your definition of a bear market is down 20% from its high, the small cap indices have gone through three mini-bear markets in the last 10 years and two in the last four years. The most recent was in Q4 of 2018,” said Nelson, Senior Portfolio Manager of Calamos Timpani Small Cap Growth Fund (CTSIX).

His thesis, then, is that small caps are nine months into a fresh bull market with the potential for significant upside.

reality small cap stocks have gone through 2 bear markets in the last 4 years

At the same time, today is not without its challenges for those investing in small caps. CTSIX, in particular, seeks companies with a sustained, underestimated growth profile whose fundamental momentum the team expects to drive price momentum.

The recent market rotation, the impact of trade policy uncertainty and corporate debt levels were among topics touched on in the webcast sponsored by Calamos Investments, produced by Advisor Perspectives and attended by hundreds of financial advisors.

We encourage you to listen to the replay of the webcast in its entirety (www.calamos.com/Sept24webcast). Below are some edited highlights of the extended Q&A with Nelson and Ryan B. Isherwood, CFA, Senior Research Analyst. The webcast moderator, fielding questions submitted by advisors, was Robert F. Behan, CFA, Calamos President and Head of Global Distribution.

About Investing in Small Caps

Q. Would you walk us through the definitions that you use for small cap and mid-cap?

A. They're always changing, I can tell you that much. Our sweet spot for small cap investing is $150 million market cap on the low end and $4 billion on the high end. We’ll go above that. In fact, in the small cap benchmark, the Russell 2000, the largest name currently is about $8 billion. That's higher than where we typically would initiate a new name, but just to give you a feel for the lay of the land as we sit here today.

We don't have a pure mid-cap portfolio that we manage, but we do have some mid-caps that we're trafficking in. We define mid-caps as $4 billion on the low end up to about $15 billion on the high end.

If you look at the Russell Midcap Index, there are some names on it pushing $40 billion market cap. That's not something that we would typically traffic into.

small cap webcast photo, Bob Behan, Brandon Nelson and Ryan Isherwood
Webcast presenters (from left to right): Bob Behan, Brandon Nelson and Ryan Isherwood.

Q. The overall level of corporate debt seems high. Is this an issue with small caps and how do you think about that for your portfolios? A related question is about interest rates—how does the overall interest rate environment factor into investing in small caps?

A. Small caps have seen overall leverage rise in recent years, but it has been on a similar trajectory with what we've seen with mid- and large caps. This higher leverage does make sense given that interest rates are so low. And actually, tax rates have come down, and that allows companies to service their debt loads more efficiently.

As far as interest rates and small cap performance, typically if interest rates are rising, that would be a tailwind to small cap performance. That's because when you're seeing rising interest rates, you're often seeing an expanding economy, and that can disproportionately benefit small companies and their income statements.

The Workings of CTSIX

Q. Style drift can be an issue in the small cap space just because of capacity or management style. Please speak to the style of the fund.

A. If you look back at the history of the mutual fund and of the composite, you'll see that there is really no drift in what we do. It doesn't matter whether small cap growth is in favor or out of favor as an asset class. You can count on us to stay in the box…It’s really the only way we know how to manage money.

Q. Please outline what your sector exposures typically are and where the opportunities are now in terms of sector.

A. We're very focused on finding secular growth—in other words, growth where you're not dependent on a robust economy. We do tend to find more candidates for secular growth in health care, consumer discretionary and technology. Not surprisingly, our overweights are in those three sectors.

Q. How do you think about cash in your portfolio?

A. Cash is kept at a fairly low level. We're consistently below 5%, for instance, and usually well below 5%. We're not typically trying to time the market or maintaining high cash levels.

Q. Here’s a question about process. We all know the small cap space has many, many securities. How do you get down to a number that's manageable for you, and then how does a stock get in the portfolio? How do you get to a number that you're comfortable managing?

A. There are 1,500 stocks roughly in the universe of what we consider investable. Most of those stocks, due to their fundamental profile are, at any given point in time, not investable to us.

Our quantitative screening—which is sort of a numerical representation of our Tier 1 criteria—helps us narrow what we’ll look at. We use quantitative screening, company touch points and industry contacts to narrow our focus to a much more manageable list of 150 to 200 stocks.

Regarding the band of 80-120 names that make up the portfolio, that depends upon the fundamental profiles of the companies. Sometimes we're finding more ideas and we’ll skew higher. And other times, if growth is more challenged, we might have fewer on the list.

For example, during the great recession, we held much, much closer to the lower end of that list because it was harder to find stocks that met our fundamental criteria. So, we have a quantitative mechanism in place to analytically distill the world into bite-size areas where we can focus our fundamental research on.

Q. Here’s a question about capacity. I guess I’ll answer this. In the strategy that is managed by Timpani, there's approximately $700 million of assets under advisement. Some of those are model assets, but you can't call them AUM. In the funds with all of our tickers, we have about $85 million.

So, the strategy has ample capacity to grow and we believe the capacity is somewhere in the larger size of the small cap index. With your help, we’ll certainly get there.

Today’s Environment for Small Caps

Q. We've had a pretty intense style rotation here recently. What’s your perspective on that and how it impacts the portfolio?

A. We don't drift and there's a lot of purity to what we do. And so, when you get a regime change like we've seen thus far in September, it has been painful for us. We’ve given back some performance, but this is very normal in the grand scheme of things. We've seen pullbacks. Every style goes through a period when it's temporarily out of favor, and we’ll see how long this one lasts.

I don't know how much more damage there could be to growth stocks overall. You have to step back and remember that growth stocks had higher valuations than value stocks for reasons. There’s fundamental momentum and a lot of reasons that growth stocks have gotten to the point they're at. And, there are a lot of reasons value stocks look so inexpensive—it's because there's lack of fundamental momentum.

Largely, that is still the case, and those two groups have converged somewhat. We’ll see where we go from here. It will be very interesting this upcoming September quarter earnings season. It will be very interesting to see the stock action of both growth and value stocks relative to the earnings reports.

We’re expecting pretty good earnings reports from most of the growth stocks, and we’re expecting pretty ho-hum earnings from a lot of the value stocks. So, the stock action in response to those reports will be extremely interesting and probably tell us more about where we are.

Typically, when you get a pullback like this, you should view it as a favorable long-term entry point. It doesn't mean we're going to have a V-shaped snapback in our particular style. It might mean that, but at a minimum, I think we start rebuilding and then long term it ends up being a good entry point typically.

September 24th Webcast Replay

Q. How does the trade conflict with China affect small caps?

A. There's definitely some exposure to small companies as it relates to the tariff noise. The sectors that have the most exposure are industrials, materials and energy, either directly or indirectly. Because we're so focused on fundamental momentum, it's kept us from wanting to make many investments in those sectors. We are underweight those groups because of the murkiness that exists partially due to the trade situation, but also just due to the global economic picture being somewhat murky.

So, for companies where we do have exposure, we've dug deep on those situations. We're comfortable with the current levels of exposure and in many cases, management teams of those companies are coming up with contingency plans to reduce their exposure to China manufacturing so they're less vulnerable to all the tariff noise.

Many of the companies that we own that had China exposure have reduced it proactively, and also they're working in concert with the Chinese to open factories in other countries. We have a couple of instances in which the Chinese have expertise in the manufacturing, and they're opening a new facility in Vietnam that will not be subject to the tariffs.

While it is a near-term headwind in some cases to the margins that a company can make, we think that if the tariff situation gets resolved, that could be a positive for the stocks we own. If it doesn't get resolved, we would expect to see the margins in those companies bounce back in short order as they move their supply chains.

Q. So, this is a question about cannabis. You cannot have a meeting without someone mentioning cannabis. Are you in cannabis? What's your view on cannabis in small cap growth?

A. We have zero exposure to cannabis right now. It's an industry we're monitoring, but it's fiercely competitive. It's early days and I'm not sure it's a great fit yet for what we do. We’ll see, but for right now, we're taking a pass.

Financial advisors, what other questions do you have? Reach out to your Calamos investment Consultant at 888-571-2567 or caminfo@calamos.com.

Click here to view CTSIX's standardized performance.

Before investing carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-800-582-6959. Read it carefully before investing.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

Important Risk Information. An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s). There can be no assurance that the Fund(s) will achieve its investment objective. Your investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. The Fund(s) also has specific principal risks, which are described below. More detailed information regarding these risks can be found in the Fund’s prospectus.

It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

The principal risks of investing in the Calamos Timpani Small Cap Growth Fund include: equity securities risk consisting of market prices declining in general, growth stock risk consisting of potential increased volatility due to securities trading at higher multiples, and portfolio selection risk.

The Fund invests in small capitalization companies, which are often more volatile and less liquid than investments in larger companies. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.

Active management does not guarantee investment returns or eliminate the risk of loss. It should not be assumed that any securities mentioned in this recording will be profitable or experience equal performance in the future.

The Russell 2000 Index is an index measuring the performance of approximately 2,000 smallest-cap American companies in the Russell 3000 Index, which is made up of 3,000 of the largest U.S. stocks. It is a market-cap weighted index.

The Russell Midcap Index is a market capitalization-weighted index comprised of 800 publicly traded U.S. companies with marketcaps of between $2 billion and $10 billion. The 800 companies in the Russell Midcap Index are the 800 smallest of the 1,000 companies that comprise the Russell 1000 Index.

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