To complement your large-cap S&P 350 ETF holding, we sorted through dozens of Europe funds looking for one that offered small- and/or mid-cap expertise. As we discuss below, Europe’s mid- and small-cap companies are currently cheaper and have higher growth rates than their large-cap counterparts. Furthermore, in any market, smaller, less-liquid firms generally provide greater opportunities for sound stock picking to produce significant outperformance. At the end of the search, one fund ruled the waves.
The AIM European Small Company fund (ESMAX) is a small- and micro-cap growth-oriented Europe-only stock fund. It’s pretty much your only choice in this area. Even Fidelity doesn’t have one, though it’s got 18 international equity funds, has had a Japan Smaller Companies fund since 1995, and is coming out with an International Small Cap fund this fall. There is an FTI European Smaller Companies fund (FESCX); it’s slightly newer and smaller than the AIM fund, and so far has a weaker record.
AIM European Small Company will normally invest at least 80% of its assets in equities of small-cap European companies. The prospectus legally defines “small-cap” as no larger than the largest stock in the U.S. Russell 2000 small-cap index, which according to Russell is defined as a market cap of $1.4 billion. Jason Holzer, the AIM fund’s manager, told us this rule is “not really a factor” since he’s sticking to firms smaller than that anyway, with a median market cap barely exceeding $500 million. The remaining 20% of the fund can be in larger-cap stocks.
European Small Company normally diversifies across at least three countries–the top three at the moment are U.K., 32%; France, 19%; and Sweden, 13%–and can invest up to 35% of assets in developing countries (not currently a factor unless you count 0.6% in Portugal). Recently the fund had 88 stock holdings.
The fund’s A-class shares (ESMAX) have a 5.5% sales charge and a 2.01% expense ratio. Class B and C shares (ESMBX, ESMCX) have no front-end charges, but their higher expense ratios (2.71%) and redemption fees make those share classes cost about the same. (For a prospectus and other information on the fund, travel to www.aimfunds.com.)
AIM European Small Company has officially been managed by Clas Olsson and Jason Holzer since its August 2000 inception, but Olsson has primarily been running the somewhat larger-cap AIM European Growth fund (AEDAX) since its 1997 inception. Named the AIM European Development fund until July of this year, AEDAX is a solid mid-cap growth offering. Olsson has also been serving as leader of the firm’s Europe/Canada investment group. Effective June 28, 2002, Jason Holzer became the lead manager of European Small Company. In early July I talked with Olsson and Holzer, who work out of AIM’s Austin, Texas, offices.
Your European Small Company fund is unusual in that it combines small-cap and Europe–and earnings momentum–as a big part of your stock-picking strategy. Olsson: Yes, we think it’s an overlooked area that provides good investment opportunities. Our investment strategy has always worked extremely well in small- and mid-cap stocks, pretty much no matter where you look. But specifically in Europe, we felt the market had become deep enough to warrant a small-cap fund. We also thought that as the European markets continue to grow, at some point the U.S. investor will start looking abroad again. And this is an area of the market where you don’t have to go to an emerging market, but you can still get higher returns than you would on a large-cap fund.
You recently remarked that U.S. investors have been putting less than 5% of their money into international equity funds. A decade ago, at exactly the wrong time, they were putting in nearly 15%. Do you think the herd is generally going to be wrong on this sort of thing? Olsson: It always is, because the herd chases performance. And there is no reason why it shouldn’t be so this time. That doesn’t just go for international funds, it goes for domestic and sector funds, whatever you’re talking about.
The Small Cap fund is very tiny still, about $24 million a few months ago. Do you think that has been helpful in terms of buying the micro caps? Olsson: It always makes a fund more flexible when it’s smaller, but we play in an area where we wouldn’t mind seeing the fund go up to about $500 million or so. It would still be flexible enough. Importantly, we think there are enough opportunities.