FidelityConnects: Beyond the benchmark: Investing in global micro caps

Pamela Ritchie: [00:04:15] Hello, and welcome to Fidelity Connects. I'm Pamela Richie. Small-caps have surged in 2025 with the Russell 2000 climbing about 14% year-to-date. That strong run isn't just a flash in the pan either. It's underpinned by improving valuations, a dovish Fed environment. Could smaller companies be the catalysts your portfolios are looking for? How is our next guest navigating a universe of thousands of less liquid, sometimes more opaque companies which are across the globe. Joining us now to unpack the investment case for micro-caps is portfolio manager, Salim Hart. Salim manages Global Small-Mid Cap Equity Fund and Global Micro-Cap Fund. A warm welcome to you, Salim. How are you today?

Salim Hart: [00:05:02] Doing great. Thanks, Pamela. Good to see you again.

Pamela Ritchie: [00:05:04] Yes, great to see you. So glad to have you here. I'll remind everyone joining you and us here today that this interview has live French audio interpretation o please go ahead and join us in either official language. Salim, when we spoke to you last it was sort of mid-year through 2025, and I think it was the anniversary of this new fund that you launched, the one-year anniversary, we were talking a lot about trade at that point and how micro-caps, actually, to an extent were protected because they often were selling to more local markets, they're smaller companies, they weren't necessarily globally trading. It was an interesting time then. Just tell us a bit about how that's either changed or some of the new parts that you're interested in right now.

Salim Hart: [00:05:52] In the first quarter a lot of global markets fared quite poorly, especially U.S. markets saw pretty significant drawdowns. The Global Micro-Cap Fund was actually up, I think, 3% or 4% in the first quarter so it kind of weathered that storm quite well, partly because of what you said, that a lot of micro-caps are very kind of niche, very geographically focused on their local markets and aren't really that exposed to trades, and also they're quite out of favour so when you kind of see a liquidity-driven sell-off and a lot of unwinding pf positions micro-caps are typically the first thing that people sell. The Micro-Cap Fund actually provided some pretty good downside protection during that. As we discussed in June I found a lot of opportunities, especially in the U.S., on that dislocated sell-off to deploy capital. I started the year about 1,000 basis points underweight the U.S. and kind of by mid-April it was underweight by only 300. I rode that back up and since then the U.S. markets have recovered well. I think I've kind of taken, again, a maybe more defensive stance where I was kind of aggressively deploying capital in the spring. There's a lot of speculation that has crept back up into the markets. They've kind of reached all-time highs again. I think right now I'm finding kind of more opportunities in higher quality names outside the U.S. Japan definitely continues to be a favourite but also more opportunities in Europe and the UK as there's more fiscal stimulus there and quite attractive valuation.

Pamela Ritchie: [00:07:36] It's a fascinating asset class that you've told us about before and I think it has a very large universe. Tell us a bit about what attracts you to this area because this is a fund that came from sort of ... it's quite organic to the way you invest. You've created this fund specifically because you like taking a look at these companies. Tell us broadly what it means to invest in micro-caps.

Salim Hart: [00:08:02] Micro-caps are really, I would say, the last really inefficient space in the public markets today. They're really uncovered, they're overlooked, they're illiquid and difficult to trade, all of that creates opportunities. There's about 7,000 to 8,000 of them in my universe across the world. I kind of invest in the bottom half of the small-cap indices all the way down into the MSCI global micro-cap universe, a huge number of stocks to sort through. I think the one thing I would like to point out and dispel the myth off the bat is the micro-caps are really not as risky as people think they are. Yes, if you were to buy one micro-cap stock it can have a very wide dispersion of outcomes. It could easily be up 100% or down 100% because they have very niche businesses. When you put them all together in a portfolio, even just looking at the MSCI World micro-cap benchmark it actually consistently had lower volatility than the MSCI World small-cap benchmark. Even just the benchmark does and I feel like the types of stocks I buy, the value stocks, the out of favour names, the higher quality names with ideally good management teams and are taking market share, have a lot of positive qualities and some growth opportunities, I feel that also provides some downside protection. I would like to kind of dispel the myth that you can't have the return associated with micro-caps without the risk, without being at very high risk, and I think we've seen that in the fund returns.

Pamela Ritchie: [00:09:34] Do I recall that some of the stocks, they're actually dividend producers which you wouldn't really think of as some of these smaller companies.

Salim Hart: [00:09:43] Absolutely. The dividend yield on the fund is approximately 3% right now which has doubled out of the benchmark and higher than the S&P 500 which is kind of considered the blue chip benchmark in the world. I think if you think about my micro-cap company, a lot of people might know a family member, a business associate, a friend who runs their business. If you think about it, I mean, maybe some people are very speculative but a lot of these are very conservatively run businesses that generate a lot of cash flow and that actually care about earning a profit. Those are the types of companies I invest in. Sure, there's a lot of micro-cap stocks that are speculative in commodities, doing crypto or quantum, that's not really the universe that I play in. An example is Seiren which is the number one position in the fund as of the last quarter. It's a 1 billion cap Japanese textile and auto parts company. It sounds boring but a third of their operating profit comes from a big growth driver for them which is vegan leather seat coverings.

Pamela Ritchie: [00:10:54] Vegan leather seat coverings. Really. Okay.

Salim Hart: [00:11:00] I find it kind of a fascinating story. It is, honestly, just a fancy name for fake leather car seats. Toyota and Tesla are their biggest customers. Tesla actually went to fully synthetic leather in 2019 and now two-thirds of all their seat coverings are made by Seiren. It's actually a pretty premium product. It's lighter, it's more durable, it's better temperature controlled.

Pamela Ritchie: [00:11:23] You can clean it off.

Salim Hart: [00:11:29] You can clean it more easily and it's also a more eco-friendly alternative, you don't have to kill cows to get it so it's better for the environment. The EV makers like it because it's lighter weight so it makes the gas mileage better. It's basically kind of becoming the new standard, so to speak. They have 40% market share in this space, combined with the fact that the company has had a 15% CAGR growth rate over the last 10 years and is expected to continue that going forward.

[00:12:22] Where the fundamental analysis comes in, our analyst has actually met with the company and their competitors. Their competitor is a large conglomerate that's kind of unfocused on the synthetic seat covering space so Seiren's actually able to take market share from them. They're in a growing market, they're at a very cheap valuation, they're taking market share, they are a leader, and again, it's a niche company that's just kind of overlooked. It's a tiny company that's just kind of doing really well. They've had positive operating cash flow every year for the last 20 years. I feel like you kind of couldn't ask for a better company in some ways. I think the only risk really is that there's some cyclicality associated with it because it is in the auto parts kind of area but I think you're more than compensated for how well run it is and how clean the balance sheet is and what a cheap valuation it's at.

Pamela Ritchie: [00:13:14] Tell us a little bit more about the process that you use to take a look at companies like this but all of the other ones that are in the fund as well. You've always had an extremely value approach to things but also kind of a quant approach to things. How does that work in today's market? You deploy AI as well, as I understand, throughout the whole process.

Salim Hart: [00:13:36] Pamela, I really try to use every tool in the toolbox to generate alpha down the micro-cap space. You kind of need it there because there are so many companies and it is so inefficient and it's harder, I guess, to gain conviction individually so you do need a diversified portfolio. At Fidelity I kind of started working on the small-cap team with Joel Tillinghast in 2009, launched a micro-cap pilot internally in 2013 so we've been managing that for over 10 years before we finally launched it as a real product, obviously, worked with Joel on Low Price and Global Intrinsic Value for almost 10 years before finally kind of launching this on my own. In my career at Fidelity  I really have been trying to mix the best of fundamental analysis with quantitative investing. I have quantitative alpha models that I built with Joel and I crunch about a million and a half data points every day just for that. Really the goal is to find great companies but then kind of rely on the quantitative processes to make sure that my emotional biases don't get in the way, that the style consistency of the fund kind of maintains its value, quality approach with the downside protection, and also use quantitative tools for what they're good at, and one is portfolio construction.

[00:14:53] Another one that I started two years ago just before we launched the fund was actually using large language models to read all of our research notes. Fidelity analysts publish a huge number of research, several thousand research notes every month. I actually have a process that wakes up three times a day using GPT-4, it feeds me a score on each research note on what the analyst sentiment is, how it's changed since the last research note and guides me to the ones that I need to focus on paying attention to, is most of the process. Really, combining art and science of quant and fundamental I think is really value add and I think they both have their own aspects that they're really good at. Utilizing the best of each I think is really important.

[00:15:38] Then kind of relying on our trading desks, technical analysis and kind of using liquidity-providing strategies to keep trading costs low is kind of the third pillar. It's really important to me to find dislocations. If I have, let's say, 500 or 1,000 good companies that I've identified I would really like to buy them at good prices, and ideally when the market they're in, whether that's the U.S. or Japan or Europe, is kind of blowing up for a temporary issue. That's kind of been the process in the fund. I think combining all those things, having that breadth and depth is really the wave of the future on how to invest.

Pamela Ritchie: [00:16:18] That's so interesting. Tell us a little bit about the companies themselves. They sound like such interesting companies. We'll ask you about a few others as well. Do they get taken out? Do they get bought out? If you think they're pretty interesting and good they probably look that way to others as well. Sometimes is that useful?

Salim Hart: [00:16:36] A lot of people have heard me talk about ... I think we've had 28 or 29 companies from the fund get bought out both by private equity, by strategic buyers, had a couple of [managing?] buyouts in Japan, I think it really speaks to the testament of these are good companies that are attractive to buyers. It's always sad when one of the companies I own does get bought out and taken away from me but on average they're at a nice premium so I can recycle the funds into something else.

Pamela Ritchie: [00:17:05] Do you get to know, I mean, as you say, these are smaller companies, sometimes I think you've said founder-led, there must be some real relationship work in there because other bigger companies can be very corporate in the way that perhaps you communicate with them, slight differences.

Salim Hart: [00:17:19] I think the analysts do have that. As a portfolio manager, as someone with a quantitative background I specifically don't want to become emotional with my companies. I don't actually feel like that's a good way to manage money. I actually don't meet with companies. I rely on our analysts who are expertise in doing that and travel all around the world and are located there as well. One of our analysts who covers foreign energy and IT services companies, just spent two weeks in Japan, has been writing lots of great notes the last two weeks on every meeting that he's had. It's probably been 30 or 40 meetings. That's really where that fundamental view comes from, Pamela. I think in order to be an unemotional investor, at least for me, that's not my specialty and not something I want to do. I own 600 companies right now in the portfolio and I like to keep it in terms of I like the companies because our analysts say they're good companies and statistically, they kind of match the process on what I'm looking for. Beyond that, if they don't match the processes or the views change those would be very quick to get out of the portfolio.

Pamela Ritchie: [00:18:28] There's much discussion about breadth right now and what that will mean for next year. Oh, you  just had a visitor there, we saw him come in and go out.

Salim Hart: [00:18:36] Naveed just walked [inaudible].

Pamela Ritchie: [00:18:40] Hi Naveed. The discussion of sort of diversification and breadth seems to be ... it's been the topic for some time but ultimately how does your fund make sure that it provides both the breadth piece for peoples' portfolios and diversification?

Salim Hart: [00:18:58] I think for people who might be overexposed to U.S. large-cap growth, obviously, this fund kind of provides the opposite to all that. I think it is a really good diversifier. It's obviously micro and heavily weighted internationally, the U.S. is only about 20% weight in the fund, and it's obviously value, deep value. I think the P/E on the portfolio is about 12 versus the benchmarks that are about double that. I think you've seen it in the returns providing good diversification. I kind of did some data crunching and looked at every quarter, when the Nasdaq 100 does really well the fund doesn't really do as well. In the fourth quarter of last year I think the Nasdaq was up 12% and the fund was up 1 1/2%. But then in the first quarter when the Nasdaq was down 8 the fund up 4. It kind of has shown that it is providing that diversification aspect. Even if you just look at the last two days, for example, Friday and Monday, you've had some decent sized drawdowns of 2 or 3% in U.S. large-cap growth stocks, whereas the Global Micro-Cap Fund was actually up over those two days. I think we've seen that diversification in practice. It makes sense intuitively given the types of stocks that it invests in. It is well diversified over 600 names so that actually really helps control kind of the risk and the overall volatility of the portfolio. My goal is to construct a very smart portfolio that's diversified and does provide investors with downside protection.

Pamela Ritchie: [00:20:33] Can you break it out into leaning into particular sectors or does that sometimes just happen because it happens? Are there any sectors that you're most interested in right now?

Salim Hart: [00:20:46] What I've found is that geographies tend to get dislocated a little bit more. I mentioned the U.S. underweight and then closing that in the first quarter. In the second and early on in the third quarter I was really finding a lot of opportunities in Japan as the currency weakened there a lot and the market underperformed quite a bit. Right now there's actually some opportunities in Europe. Maybe UK financials is a place, some insurance companies in the UK. It is a bottoms-up stock picking process, Pamela, so it's a little bit less of making a macro top-down call and I don't really think of the world in terms of sectors that much but maybe I can just talk through a few areas, a few stocks in the top 10 and where I'm seeing opportunities in the world among those, if that would help.

Pamela Ritchie: [00:21:37] I was going to say pick up on financials specifically if that's of interest to you.

Salim Hart: [00:21:42] In the U.S. it's interesting. My U.S. exposure, which is about 20% of the fund, is heavily weighted in U.S. micro and small-cap banks and diversified financials. Everybody hates them, they're very cheap. It's a tiny company, I think it's 300 or 400 million in market cap.

[00:23:10] That's an area in the U.S. where people seem to hate financials and especially banks because interest rates were supposed to be good for them and then they actually ended up being bad and lower interest rates are now supposed to be good, it's just like they've kind of never really caught their own because they are actually kind of boring and just generate a lot of cash in a very consistent way. If you don't like that then the banks are not the place for you. I really like Japan and I've found a lot of staffers there this year, staffing firms, as their economy kind of found its footing. In the top 10 is one of them, UT Group. It's a staffing firm that's only trading at 9 times earnings with a 6% dividend yield run by the founder. They basically focus on temporary staffing for the manufacturing sectors, semiconductors, autos. Great valuation for a well-run company by a founder for its net cash growing double-digits with a little bit of cyclicality [inaudible].

[00:24:19] Stocks like that are things that I really like. Maybe the last example from the top ten I like to talk about because it's Canadian, is Oceana Gold. It's not a micro-cap anymore but it's up 200% from where I bought it originally. The nice thing about the fund is I never have to sell a stock. If we ever do see a 10 billion, or we can always hope for 100 billion cap company, in the holdings that would be a success story in terms of a company doing really well. Oceana wasn't necessarily a play on gold, it was just a good company trading at a very cheap valuation for where gold prices were, and to some extent gold prices did go up and that's helped the whole sector. I've trimmed a lot of names. Oceana's kind of interesting because they're in kind of relatively safer, more stable geographies. They have a mine in South Carolina and in New Zealand. Our analysts have identified some upside optionality in some of those minds beyond kind of just what they're doing. It's run up a lot. I wouldn't necessarily say it's super cheap anymore but given where gold prices are it's reasonably valued and has kind of migrated into the top 10 as a result of price [depreciation?].

Pamela Ritchie: [00:25:30] That kind of takes care of the question, your exit strategy. You don't need to exit once they go up over the cap size that you generally have as your ... so what do you enter at?

Salim Hart: [00:25:40]  I think that's very important. A lot of people have heard kind of Joel Tillinghast story about Monster Beverage.

Pamela Ritchie: [00:26:15] There's a lot of discussion about private markets, we know this, and taking a look at the either pros and cons of investing in a private market which is sort of truly illiquid at certain times entirely. Does this, I mean, how different are these companies? They obviously are public companies so they don't have that same profile but I wonder if you might compare the two because there's great interest in the private markets right now.

Salim Hart: [00:26:41] Micro-caps are kind of an interesting alternative to privates because they're in some way semi-private. They trade by appointment often. They're often run by a concentrated shareholder, whether that's a founder of the family. I think what I look for in micro-caps a little bit is maybe less leverage. I think when a private equity firm tends to buy companies they consolidate them, they might lever them up, they might really take cost out of the model. I'm a little bit more looking for companies that are more conservatively managed but those often do find very attractive targets for private equity to get bought out, as we discussed.

[00:27:20] Micro-caps versus kind of private equity, I think the private equity model is kind of to buy companies, clean them up or make them more efficient, whether that's financial leverage or operating leverage, and then kind of turn around and sell those companies. I think you need an exit strategy as a private equity investor that I think maybe should worry some people as a lot of private equity has invested a lot, and as those companies kind of get to their 7 or 10-year period where the fund needs to exit, and if you see a lot of private equity companies needing to exit these things and not that many buyers around, there might be ... I think it could provide some issues, and I think you're already seeing that at the margin in terms of exit strategies not going particularly well for them.

[00:28:09] I'm not a big fan of privates in terms of, you know, there's now trading venues for private companies being created and it's kind of like, why do you recreate the wheel? Being public, being traded on an exchange, having financials vetted and filed with a regulatory authority, I think there is a little bit more safety in that to some extent. I think there are some interesting parts of private equity in terms of maybe being able to make either shorter or longer term decisions better, depending on their time horizon. I'd say micro-caps provide an interesting alternative to that.

Pamela Ritchie: [00:28:52] What about as an alternative to, you know, buying into the experiences of small-caps which will have slightly different entry points because some of them will be maybe bigger than micro. That part of the market, again, the relative trade-off there.

Salim Hart: [00:29:09] When you buy an index you get all the money losing companies, you get all of the badly run companies. I think maybe in the most efficient spaces is kind of you go up cap, large-cap, maybe that's a good alternative. I would say stock picking is pretty important in the micro-cap space, just being able to ideally avoid some more of the sketchier companies out there. Obviously, I'm an active fund manager so I'm going to see the world that way a little bit. I do think stock picking is kind of important down cap as well as managing trading costs. Personally, I probably ... I think, Pamela, if you just looked at micro-cap benchmark returns versus, let's say, small or mid-cap benchmark returns, I'm not actually sure that you would find that just buying an index down in the micro-cap space has been better than that. I do think that's kind of why I wanted to launch a micro-cap fund specifically is to be able to take advantage of the active management opportunities down there.

Pamela Ritchie: [00:30:17] Fantastic. It's incredible the way you manage and the way you look at companies and how ultimately you gather that information. You mentioned many of the ways that you collect information, is there sort of a final thought on how this fund and the way that you manage it might take a look for 2026? What's your overall view for the markets, or will it just kind of carve straight through?

Salim Hart: [00:30:44] Given the kind of euphoria that's been experienced in the market, I don't know that we touched on it that much but if you just look back at October it was amazing. You just had quantum names and crypto running. You had the New York Stock Exchange, intercontinental buying or investing billions of dollars in a prediction markets company, basically sports betting. You've kind of had retail activity both in options and in single stock levered ETFs at all-time highs. The lines between investing and gambling, I feel like, are getting blurred, especially in the U.S. markets. I think that just has never ended very well historically. I think people do need to be kind of cautious of the risks out there and the sentiment out there. For me, while I did find opportunities early in the year to deploy a lot of capital right now the fund basically has the lowest beta since it started, the highest quality exposure, cash is at the highest level.

[00:31:46] I'm pretty defensively positioned going into the new year. Returns have been good in the fund and I kind of want to protect those a little bit and kind of wait for new opportunities and dislocations should they appear in the markets to be able to kind of take advantage of. The old Warren Buffett saying, you know, be greedy when others are fearful and fearful when others are greedy, I really do try to implement that and I feel like a lot of tools are in place to be able to kind of take advantage of those opportunities, both on the upside and the downside [inaudible].

Pamela Ritchie: [00:32:18] We really want to thank you for bringing your fund to this audience and to us. Thank you for sharing your time, Salim, and wish you the best for the holiday season.

Salim Hart: [00:32:27] Absolutely. Thank you, Pamela.

Pamela Ritchie: [00:32:29] Salim Hart joining us today from Boston. Coming up on the webcast over the next few days, tomorrow portfolio manager Dan Dupont. He will join us live from Montreal in French at 10:30 a.m. Eastern and then we'll be speaking with him here at 11:30, regular time, Eastern time. Dan will unpack where he's finding opportunity as we head into the new year, ultimately the story for value, what he's been doing this year, biggest lessons, and also a look into next year.

[00:32:56] On Thursday this week, Fidelity Director of Quantitative Market Strategy, Denise Chisholm, who comes with incredible research to share with you. You never want to miss this discussion. She's going to dig into the story of jobs, where they fit, ultimately the economy, where it's going, then, therefore, what you want to take a look at in terms of sectors.

[00:33:17] On Friday Andrea Rigobon, who's Director of Procurement and Senior Legal Counsel at Fidelity, she joins us to take a look at the key regulatory topics of 2025, some new updates that have come out just recently and ultimately what they mean for the horizon look for 2026. This webcast will feature live French interpretation. Thanks for joining us here today. I'm Pamela Ritchie.