Small-cap stocks often fly under the radar when markets are volatile, but this year, Third Avenue Small-Cap Value Funds may be changing the way investors think about them. According to data from FactSet, the fund is down 4.5% year-over-year, outperforming the large-cap S&P 500, which lost 12.9% over the same period. The fund’s performance is not necessarily indicative of small-cap stocks outperforming their larger counterparts broadly. But Victor Cunningham, portfolio manager at Third Avenue Small-Cap Value Fund, suggests the gap between small and large caps may be smaller than expected. “For a long time, large caps and small caps have been in pretty tight ranges with each other,” Cunningham told CNBC’s “Squawk Box Asia” on Wednesday. Big-cap companies have been the “outside beneficiary” of lower interest rates, he said, but rising rates and a de-globalizing world could tilt the balance towards small-cap. As it stands, the Russell 2000 Index — the small-cap benchmark — is down 15.1% this year, closely tracking the S&P 500’s decline over the same period. Focus on Fundamentals While he believes the Russell 2000 is nearing its bottom, Cunningham said he thinks some small caps will perform worse than others. Notably, he said he thinks the reduction in monetary stimulus will affect particular sectors. “I think some of those companies are going to have a more challenging time getting themselves financed and growing over time,” he said. Against that backdrop, Cunningham said he believes it’s important to choose carefully. His advice: Focus on the fundamentals. Read more Asset Manager Predicts the Next Bull Market – and Explains How to Position It How to Invest for Yields to Beat a Bad Year for Stocks and Bonds – According to the Pros of Wall Street that these small caps are good buys as the recession looms – BofA gives up a 40%. When valuing companies, Cunningham prefers those with financial strength and management acumen. They like stocks that are trading at a discount and have “favorable prospects” for increasing their net asset values. In particular, he favors well-capitalized companies with a “history of playing offense when others are playing defense”. According to Cunningham, such companies can cope with unforeseen events such as the COVID-19 pandemic without being “forced to make decisions”, which can be detrimental in the long run. “We want to arm ourselves with managers who are willing to buy companies and make acquisitions in a more difficult environment,” he said. “And that’s really important to us. We want to see the kind of aggression where other management teams are intimidated.” What’s in the Fund The Fund Washington Trust counts Bancorp among its top 10 holdings. According to Cunningham, the bank has had a “stellar” credit history even during the 2008 global financial crisis. He added that the bank’s capital position is also strong and is expanding its net interest margin – a key profitability metric used by banks. Electrical infrastructure firm MYR Group is another. Cunningham said he likes the Colorado-based firm for its financial strength and orderly growth. He said he sees the company benefiting from higher infrastructure costs, the proliferation of renewable energy and grid modernization. He said MYR has a “record” order book of $2.4 billion. The fund also owns shares of Texas-based Tidewater, the world’s largest supplier of offshore supply vehicles. Cunningham said the company has spent money promoting fleet size and quality over the years and now has one of the newest fleets in the world. The company is set to take advantage of higher spending in the oil industry, which is still down 45% from its previous peak in 2014, Cunningham said.
