It’s also important to research the companies on the ground. “We believe that generating long-term excess returns is driven by having a differentiated view of long-term fundamentals,” she says. “An important part of this process is evaluating management’s long-term strategy and the likelihood of successfully achieving it. In short, it’s driven by hard work, not shorthand valuations.”
While the small-cap fund owns companies with a median market capitalization of around $5 billion, the mid-cap fund’s comparable figure is $14 billion. Companies in the small-cap product have revenue under $500 million, while the mid-cap names reach that level and go beyond.
Because the small-cap fund zeroes in on rapid growth, the emphasis is on companies with the ability to quickly expand revenues, unit volume and market share. In the mid-cap fund, where she anticipates slower but still robust growth among the portfolio companies, she looks for those enjoying tailwinds—when they change management, for instance, boast product innovation, make mergers and acquisitions, restructure, or benefit from new regulations. Any of these developments can lead to continued earnings growth and price/multiple expansion for mid-cap companies.
The sector weightings also differ in the small and mid-cap funds. The former is very heavily exposed to health care and technology, which make up about 80% of the portfolio. Those sectors, she says, tend to fit her quality and growth parameters best in the small-cap space.
The mid-cap fund has a somewhat broader palette. “It’s more diversified among sectors because we see more proven businesses that have withstood the test of time,” she says. Consumer discretionary represents the mid-cap fund’s largest sector overweight relative to its benchmark. “That shows you there are so many interesting consumer discretionary companies that are investable, such as Lululemon and [DraftKings] and Chipotle, to name a few. I liked these mid-cap names when they were smaller, but they were just extremely volatile. But now they have different idiosyncratic drivers that make their moats much wider and stronger.”
Unlike its small-cap cousin, the mid-cap fund is underweight in technology, where the valuations are too lofty. “Many technology companies, including those in the mid-cap space, have already gone up a lot. Large cap is more expensive than mid-cap, and mid-cap is more expensive than small-cap tech.”
Nonetheless, she added some technology stocks to the mix earlier this year as the market downturn made prices more attractive. One of her tech investments, MarketAxess, operates leading electronic global trading platforms for fixed-income securities, providing better liquidity, improved execution quality and significant cost savings to clients. Zhang was familiar with MarketAxess because it was once a holding in her small-cap portfolio, but she sold it when its market capitalization expanded. The company has achieved greater than expected revenue growth and market share gains this year, and it’s benefiting from a secular advantage—the increased penetration of electronic trading in fixed-income securities.