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Different is better in systematic small caps
The small cap sector has traditionally been the domain of the underinformed and underprepared. But by taking a fundamentals-based systematic approach, Blue Orbit is hoping to change the game.
“There’s a real clear gap and an opportunity for us to approach this from the ground up,” said Megan Talmage, Blue Orbit director and portfolio manager. “We have a lot of experience in executing, implementing and trading strategies in small caps, and a strong knowledge of the market segment both in Australia and globally. We wanted to build something better, specifically targeted at the idiosyncrasies of this area.”
The Blue Orbit Global Small Cap Systematic Alpha fund, launched Tuesday (October 5) aims to invest in “the engine room of global growth” by taking a systematic approach with fundamental oversight that’s rare for the segment. Few managers have employed quant strategies in the small caps space despite their ubiquity in large caps, creating a “low level of quantitative saturation”. Low analyst coverage and low liquidity also create pricing inefficiency, meaning the segment “is really ripe for a systematic strategy to be able to harvest some long-term, sustainable alpha.”
“There are some really big companies in this space of $2 billion plus market cap that are still classified as small because the mega cap stocks in the US have just pushed everything down into what’s effectively a mid-cap universe,” Talmage says. “We see it as a growth market segment – there might be a bit more volatility, and inefficiency in the pricing, but that creates a lot of opportunity to capture these companies and generate some outsized returns.”
Some investors, particularly those that have to justify their investment decisions to a regulator, have historically been leery of what’s called the “black box” – the lack of information around why a quantitative strategy does what it does, and the concern that even the manager might not understand it (and then there’s the argument that the brain most active managers rely on is the ultimate black box, accountable to nobody but itself). Talmage says that the systematic approach “should be a tool of the investment professional” rather than a replacement for it, and Blue Orbit generates its alpha signals based on fundamental, bottom-up research and client consultation.
“We’re the ones driving the portfolio construction,” Talmage says. “It’s not press a button and “that’s the portfolio” – we’ll go over it with a fine-toothed comb and ask “Are we comfortable with this? Is this achieving our objectives?” It’s much more a rule-based systematic framework to implement what would look more like a traditional fundamental bottom-up manager – without the gut feel.”
“Most small cap strategies have been built and developed on US large cap data sets and rolled out to small cap segments. So after years of fighting against these strategies and trying to make them work in this segment, we thought, why don’t we take our unique understanding of small caps – the composition of it, and what actually works and doesn’t work – and build up research specifically targeted to outperform in this area.”
Blue Orbit was established in 2018 by Adam Randall, Megan Talmage, Julie Andrews and Damien Green. The company is majority owned by its founders. Lewis Bearman, former CEO and COO of Perennial, joined in 2020, while Cindy Chiang joined in 2019 as operations and compliance manager. More recently, Shangitha Rajendran, former Vanguard senior portfolio manager, joined to round out the portfolio management team. Blue Orbit’s founding members founding members from IFM were all involved in managing large and small cap quantitative strategies, where a growing frustration about the inefficiency of quantitative strategies in small cap markets saw them strike out on their own.
“When we first founded Blue Orbit we planned to launch a global small caps strategy. We have spent a lot of time and effort developing the investment strategy, and the whole team has done a fantastic job to launch this as a wholesale registered trust,” Randall said. “This is a big step in the growth of our business, and we are pleased with the great support from our partner Costa Asset Management.”
Blue Orbit also tailors its approach and provides a unique fee structure, typically through a base fee for the overhead and a performance fee, which is negotiated around various desired investment parameters.
“Accessibility is very important,” Andrews said. “In this type of environment we provide a very customised opportunity. Everything that we do – whether it’s a high-net-worth individual, a high-net-worth family office, and then an institution – still has that level of individual care that we want to give to them.”
