On May 23, 2019, Harbor Capital Advisors did a hard reset on Harbor International Small Cap (HIISX). Over its first three years, the fund’s returns trailed nearly three-quarters of its peers with only a tiny bit less volatility. Harbor chose to empanel a new subadvisor, Cedar Street Asset Management which was founded in April of 2016, is an employee-owned investment management firm and has $220 million in assets under management as of May 31, 2019. Since Cedar Street brings a distinct strategy that has little in common with their predecessors, MFO classifies this as a new fund, hence a new fund Launch Alert.
The managers are seeking long-term growth of capital. The plan is to invest in a fairly compact portfolio of small cap stocks, primarily but not exclusively domiciled in developed international markets, using Cedar Street’s disciplined, valued-oriented approach.
What are they planning to do?
The guys will build a portfolio of 50-70 international small cap stocks. The current market cap range for their universe is about $100 million – $8 billion. While they have the authority to invest in emerging markets, they anticipate that direct EM exposure will be “minimal.” Position sizes will be “conviction weighted” but any individual position is capped at 5%. They anticipate turnover in the range of 25-35% which implies a typical holding period of three to four years.
In building the portfolio, they give exceptional attention to downside protection. The team’s investment process review places the “downside review” before the “upside analysis,” which strikes me as singularly sensible. They have a strong preference for value-priced stocks of firms with solid underlying businesses and clean balance sheets. They also spend a lot of effort in a governance analysis. They argue that “Because of varied laws around corporate governance and knowledge of the local players in the markets and their views on minority investors, Cedar Street feels that a detailed review of corporate governance practices is key to success in this space.”
Who’s going to do it?
Jonathan Brodsky, Founder and Principal, and Waldemar Mozes, Director of Investments for Cedar Street, will be the portfolio managers for the Fund. Mr. Brodsky co-managed Advisory Research International Small Cap Value from its launch in 2010-2016, Calvert International Opportunities from 2011-2016 and Acuitas International Small Cap from 2014-2016. Prior to joining Cedar Street, Mr. Mozes joined TAMRO Capital Partners LLC as a manager in 2008 after stints with Artisan Partners and The Capital Group, adviser to the American Funds. At TAMRO he developed the international small cap strategy and managed ASTON/TAMRO International Small Cap Fund (AROWX/ATRWX) from its launch in 2014 to its untimely liquidation in January, 2016.
In the topsy turvy world of asset management M&A Advisory Research was bought in 2010 by Piper Jaffray then sold again in 2019 while Aston was bought in 2016 by AMG, with all of its funds absorbed or liquidated.
Why might the fund warrant your attention?
There are three arguments for considering the fund.
1. International small caps are a major asset class.
In rough terms, four-five thousand stocks, 46 countries with, depending on how you count, somewhere between 100-200% of the total market capitalization of the two thousand US small caps. Collectively, they represent about 6% of the global stock market.
2. You’re underexposed to them.
The average US investor holds about 15% of their portfolio in international stocks but the average “core” international fund only has 1.5% of its money in small cap stocks. In rough terms, the average US investor might then have 0.225% in international small caps, about a 25:1 underweight.
The bias toward international large caps is ironic since small caps have greater price inefficiencies linked to low (and falling) analyst coverage, substantially higher 10-year returns than their large cap peers, higher risk-adjusted returns, lower correlation to the US market and better valuations. And their advantage over international large caps has been persistent over time and across markets.
As of May 2019, GMO projects international small caps to have higher returns than any asset class outside of the emerging markets over the next five to seven years.
3. The managers have a pretty solid record in exploiting them.
The managers’ records at their prior funds were quite solid, though in the TAMRO / Aston case regrettably cut short. Cedar Street has enough AUM that they’re been able to build out a robust analyst corps in order to find the opportunities that firms relying on “bought research” might miss. Their screening process helps them reduce a 5,000 stock universe down to an investable 500 stock one, with something like 100-200 names on their shopping list.
Potential investors should be aware that the process of portfolio transition could trigger a substantial short-term capital gains accrual, which might mean an unusually high tax bill.
The administrative details
The minimum initial investment for the retail shares (HIISX) is $2,500 and the expense ratio, after waivers, is 1.32% on assets of $54 million. The fund offers three other share classes.
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The fund is available through Schwab, TDAmeritrade, Vanguard and a few other platforms. Its website, Harbor International Small Cap, doesn’t yet offer commentary from the Cedar Street team. The Cedar Street Asset Management site isn’t noticeably richer, except for a bunch of video clips (2016-19) on the In the News page. Those mostly offer commentary on external events (“X is overpriced”) rather than discussions of strategy and approach.
The general case for international small cap investing was nicely summarized in a December 2018 white paper from AMG. It’s worth reading for folks new to the field. Mike Lipper, president of the Royce Funds, has a comparable piece (May 2019) but it requires a slightly annoying registration in order to get access.