European Small & Mid Caps: investing in innovation and long-term growth

The last two decades have seen fascinating and structural changes in our society. This is an irrefutable fact that we can verify in every sector of activity but that we observe with greater impact and intensity in segments such as medical technology, industrial automation or digital innovation.

Hans Rosling demonstrates this through empirical facts in his book, "Factfulness". One example of many is how the human species has achieved a longevity, on average, of 3 years more for each passing decade, with technology and innovation being the main catalysts of this great milestone. And this has been achieved through structural investment in innovation and R&D by many companies that has led to an extraordinary impact on the day-to-day life of society globally. Best of all, this process is far from over.

After the good performance of stock markets and portfolios over the last 3 years, rotation or consolidation movements are not abnormal. In an environment of higher but still pro-growth interest rates, shortages of components/commodities, which will gradually diminish (noticeable in company announcements over the last few weeks), with the exception of semiconductors which remain in high demand but will again see a normalisation over the next few months, the next few quarters should show good growth at the global level.

Furthermore, we continue to insist that a normalisation of rates is normal, necessary and beneficial. It is a reflection of better economic conditions after the 2020 crisis. If rates rise and normalise, it must be for a good reason: growth needs less financial support, and, moreover, demand today is actually very strong.

On the other hand, markets are inefficient in the short term, as reflected in the volatility we have experienced over the last few years, in 2020 with the pandemic, but also in 2018 with the trade tension between China and the US or in 2016 with Brexit. However, in the long term their efficiency increases considerably and companies that grow and create value for their shareholders and our society will see this reflected in the long term in the rise of their share price.

Against this backdrop, we can highlight a number of advantages of the small&mid caps in our portfolio. In an environment of rising inflation, they are companies capable of passing on this increase in price to their financial margins due to their leadership position. Furthermore, the fact that they are cash generative companies and finance their future growth through the reinvestment of their net profits means that a possible rise in interest rates will not make their debt more expensive and, therefore, their balance sheets and profitability will not be weakened.

Finally, companies focused on business models with strong structural growth estimated for the next 3 and 5 years could be affected by a rise in interest rates that could occasionally lower margins in the short term, but being invested with a truly long-term view on the best business models, our expectations would not be modified at all.