Brad McGill's fund is beating 99% of its peers this year. The small-cap manager shares how he invests for big wins and where he is finding opportunities amid a 39% return year-to-date.
- Brad McGill is the portfolio manager of the $313 million Aperture Discover Equity fund, which has returned almost 39% so far this year, beating about 99% of its category peers according to Morningstar data.
- In an in-depth Q&A with Business Insider, McGill shares his investment philosophy and process, where he is finding the best opportunities now, and how he views current market conditions.
- He also reflects on what it's like to work at Aperture Investors, the $3 billion disruptive boutique that charges ETF-like fees on its funds unless they beat their benchmark.
- Visit Business Insider's homepage for more stories.
Small-cap stocks have been on a tear recently as positive vaccine news encourages investors to bet on a sped-up economic recovery that will boost smaller US companies' growth prospects.
We caught up with Brad McGill, a first-percentile small-cap portfolio manager, to learn about how he seeks out companies that he thinks can "generate a minimum of 50% absolute return over two years."
McGill runs the $313 million Aperture Discover Equity fund, which has returned almost 39% and beaten about 99% of its category peers so far this year, according to Morningstar Data.
His emailed responses to Business Insider are relayed below.
How would you characterize your investment philosophy and process?
At our core, we are long-term investors. The Discover Equity strategy is centered around the idea that small caps have the ability to change dramatically over a 2-4-year time horizon. And as students of business models, we look for companies that are entering into dynamic periods of their lifecycle where they are evolving into their longer-term potential. This positive change and dynamism often result in an acceleration in revenue growth, better margins, and return structure. Our entire investment process is centered around this idea.
In regards to process, we have four key investment criteria that we consider for every potential holding and that we focus our research process through – transformational change/business quality; management, moat, and pricing power; thematic tailwinds; and valuation/ asymmetric risk-reward.
I've been a small-cap specialist for most of my career. This has allowed me to develop both a portfolio construction method and a set of investment criteria that allows us to create a true, best-ideas portfolio of equities that we think can generate a minimum of 50% absolute return over two years.
We've developed a set of proprietary tools to help scour our investable universe of over 2000 companies in order to select what we believe are the most compelling 20-30 positions. I've invested in some extraordinary companies over my career, some of which we saw potential in early and grew into large-cap companies that dominate their respective markets. But that is only one aspect to our approach – we also own niche businesses with good pricing power and margin drivers as well. Ultimately, we run a balanced portfolio of secular growth and cyclical companies – but each one has elements of change and acceleration.
Where are you finding investment opportunities now?
Our expected holding period is 2-4 years. So, while I recognize COVID-19 cases are increasing, I think it is prudent to consider that we are closer to the end of this period of history than the beginning. Therefore, we are able to look out towards the post-COVID era which positions us to invest in companies that may have underperformed during the pandemic but could potentially double or more in the coming years. We refer to these holdings as cyclical laggards.
Can you share the investment thesis behind some of the outperforming stocks/top holdings in your portfolio such as YETI Holdings (YETI), Everbridge (EVBG), and Ingevity (NGVT)?
We often invest in innovators and disruptors – and these stocks have fared very well this year. Many of our companies benefit from the lifestyle shifts in the consumer space, and are positioned well to engage customers directly online, through digital commerce and social media. What's interesting is that these companies were growing significantly pre-COVID, but their share gains accelerated as they were open for business.
How do you decide whether to take a short position in a small-cap stock? And can you share one or two stocks that you are shorting currently?
While our strategy allows for shorting up to 15 positions, we've been less active on the short side this year. But our short criteria aims to look for businesses that are experiencing negative fundamental change – those that are share losers, have weak pricing power, and where we feel the valuation has asymmetric downside risk. What's great about Aperture's strategies is that we short only to generate positive returns, so we don't have to maintain a large short portfolio to limit our net exposure. We see more opportunities on the short side emerging given the strength in the market, so stay tuned on that.
How do you think of the market conditions today?
It's been an extraordinary year for sure. With the election, the pandemic, historic government stimulus, and the related economic impacts, there are so many crosscurrents in the market. As I mentioned earlier, we are finding opportunities in companies that have been left behind during COVID – those that have financial staying power but their demand profiles are negatively impacted. In each case, we believe there are good changes occurring and better demand will unlock some exciting earnings power.
What would be your biggest piece of advice to investors right now?
Time horizon is your greatest ally. We think less about what has worked over the past year and are positioning a portion of the portfolio for ideas that should thrive in an economy post-COVID. There will be rotations and crosscurrents in the market – but we expect our criteria should overpower these short-term shifts over a market cycle. I heard someone say recently that post-COVID, we are looking forward to the roaring 2020s. I like the sound of that. Small caps would do quite well in that scenario.
How has been it like working at Aperture Investors given its unique compensation model and culture?
I have always invested for alpha generation – so Aperture is a good fit for my investment style and the model resonated with me. Peter Kraus has populated the firm with smart, capable people that are passionate about investing. I think we punch well above our weight for a small firm, as his model attracts confident managers that wish to align with investors in a way that is rare in our industry. I think that our model is a testament to the idea that active management is not dead, but rather that with the right managers and structures in place, incentives can be aligned with clients.
How did you come to build a career in investing? And what keeps you going in investing?
I think it's a fascinating industry where we have a front-row seat on everything from technological progress, innovation, shifts in consumer behavior and demographics, to macroeconomic changes, and this year a pandemic. It's a humbling business that is constantly changing – and during my 25-year career, I have found that my learning curve never flattens.
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