Small Cap Investing in Volatile Markets


The third point is why we’re optimistic about equities and how we look at it right now. A lot of people are running away from equities and they’re moving into cash or other safe havens like bonds. Now, when we look at equities, not only do we see dividend yields that are far in excess of Treasury bond yields, you know, over 100 basis points and the widest in over half a century, but we see the equity earnings yield. In other words, the inverse of the P/E, the equities earnings yield exceeding Treasury bond yield by as much as it has since the Global Financial Crisis, about even to the Global Financial Crisis. So, you’re getting paid about 600 basis points more in equity earnings, in terms of a yield, than you are on the 10-year Treasury, about 7% versus 1%. And we’d note that earnings have grown in every 10-year period over the half-century. In fact, the average is about 7% annually which is about 90% over a 10-year period. We really like equities as opposed to other asset classes, even in this environment, because of the very strong likelihood that earnings grow over a 10-year period and the fact that the dividend yield and the earnings yield far exceed what you get in safe havens such as Treasuries. The fourth point is growth versus value stocks. Growth is dramatically outperforming value for the Russell 2000 indices. The Russell 2000 Growth index is outperforming the Russell 2000 Value index by about 500 basis points year to date. We think that there are structural reasons for that, and cyclical as well. Some of the reasons we think that growth is outperforming is: one, because growth stocks are less dependent on the economy. They have their own secular growth drivers and rely less on overall economic growth. Two, they have less exposure to interest rates. Obviously, there are a lot more financials in the value part of the stock market. And as interest rates fall, that’s worse for value stocks than it is for growth stocks. You could argue it’s a benefit to growth stocks.

Third, growth stocks are much more innovative, which we’ve written a lot about. I invite you to look at the Insights section on for more of our work there. And lastly, growth stocks generally have much better balance sheets, less leverage, less debt than value stocks, and that’s really important in a crisis such as this so that these companies can control their own destinies. The last point I wanted to makewas regarding active management, which I think is a good segue into handing it over to Amy. Active funds have historically outpaced passive indices, theS&P 500, by about 100 basis points during recessions. But one thing I thought was very interesting is that correlations amongst S&P 500 stocks, and stocks across the stock market, are the highest on record back to 1995 we had data. And what that means is that the stock market is basically throwing the baby out with the bath water. It’s saying, “Sell all stocks in light of this pandemic.” We think that that sets up a really good environment going forward for active managers who are good stock pickers because it’s not correct. Weare optimistic that the environment going forward, once this pandemic subsides and stocks are able to differentiate themselves, that stock pickers will really come out on top. Brad Neuman (BN): Amy, you’ve been a portfolio manager for a long time, and during your career you’ve been through many financial and economic crises. Can you help us understand how you’re feeling about the Alger Small Cap Focus Strategy portfolio in light of the current crisis? Amy Zhang (AZ): Yes. I’ve been managing the same strategy for over 17 years, being a portfolio manager, and also as an investment professional, I’ve been through many crises including: 1998, 2002, and 2008, and this crisis is different. But on the other hand, also, our portfolio is very different from our peers. I want to move to the Q&A with Amy.

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