The outlook for global small- and mid-caps is encouraging. Rate cuts are beginning to come through and, in line with historical trends, are driving the asset class’s outperformance. The ACWI Small and Midcap (SMID) Index was up 9.3% in the third quarter, outpacing its large-cap equivalent by 2.9%. As we look to 2025, extremely attractive relative valuations should further support SMID outperformance.
Word on the street
In September, we attended the Caixabank Conference in Madrid and the Kepler Cheuvreux Conference in Paris. These events brought together companies from the Iberian and Benelux regions, respectively. Below, we detail the highlights.
- Electric vehicle (EV) penetration: there was significant interest in the proliferation of Chinese EVs in Europe. This included how European auto parts manufacturers and OEMs (original equipment manufacturers) are positioning themselves in response.
- Cyclical market uncertainty: visibility is limited in the more cyclical areas of the market such as industrials, automation, and chemicals. This uncertainty raises several questions: have we reached the bottom? When will the recovery begin? What form will the recovery take? And how will macroeconomic developments influence it?
- Defensive chemicals and sustainable products: the feedback for the defensive chemicals sector seemed relatively positive and demand for sustainable products remains good. The normalisation of supply chains and general stability in Southern European markets, particularly Italy and Spain, leave us upbeat about the prospects for our stocks in these countries.
- Inflation and pricing strategies: companies have combatted inflation by raising prices, which has helped improve margins in the past couple of years. However, as the cost of raw materials decreases, the challenge now lies in achieving the right balance between price and cost, while addressing negative price momentum.
Artificial intelligence (AI) and luxury goods: the luxury goods industry can leverage AI developments to enhance processes, and to lower energy and water consumption. AI can also help monitor supply chains to prevent potential human rights violations. This is particularly relevant considering recent discussions surrounding luxury goods makers and issues related to labour management along the supply chain.
Spotlight on supply chain
Supply chain concerns play a crucial role in evaluating companies based on environmental, social and governance (ESG) factors. These issues are relevant not only for the luxury goods sector but across all industries.
In most cases, the larger the company, the more extensive its supply chain and the greater the associated risks. This is due to the difficulties in maintaining comprehensive oversight, particularly regarding products and services sourced from overseas.
In our strategy, we value companies that demonstrate the following characteristics.
They maintain clear visibility of their value chain, and understand their exposure to various risks and geographies. They also conduct announced and unannounced audits of their suppliers, either independently or via trusted and well-regarded third-party providers.
They conduct comprehensive onboarding and ongoing due diligence of their suppliers, considering not just financial aspects but also environmental/climate and social factors. Companies must also ensure, to the greatest extent possible, that the suppliers take appropriate measures to address and mitigate any environmental risks. Furthermore, it's crucial that they verify their labour force is employed under conditions that uphold human dignity and comply with national standards
ESG evolution
We frequently engage with our companies to assess the evolution of their ESG risks and opportunities. Whenever possible, we also visit their manufacturing sites to acquire a more comprehensive understanding of their operations.
In May 2024, the Council of the European Union adopted the Directive on Corporate Sustainability Due Diligence. This aims to foster better practices and behaviours among larger companies, which will, in turn, positively influence smaller businesses within their supply chains. While SMID enterprises are not directly covered, they will likely indirectly benefit. This should help address the adverse impacts on human rights and the environment.
ESG in action
We recently visited Brunello Cucinelli in Solomeo, Italy. This luxury fashion brand gave us an in-depth tour of its manufacturing facilities as well as the wider Solomeo Village, which has been revitalised thanks to the efforts of the Brunello Cucinelli Foundation.
The company’s philosophy is inspired by its founder and rooted in humanistic capitalism. At its core, Brunello respects the dignity of its labour force and the location in which it operates. Notably, the brand has established a local School of Arts and Crafts, providing individuals with the opportunity to learn valuable skills while earning a fair wage and enjoying excellent working conditions.
Employees also benefit from initiatives designed to enhance job satisfaction. These include complimentary meals, opportunities for advancement and professional development, and wages that exceed industry averages – all set against the rural backdrop of the Perugia area.
Furthermore, 94% of Brunello’s raw material suppliers operate in Italy. The company has numerous long-standing relationships, such as the 30-year association with Cariaggi Lanificio Spa, which supplies cashmere. Its procurement of leather from top tanneries in Italy, France, and the Iberian Peninsula, underscores its commitment to quality and sustainability. Additionally, the company works with 393 medium sized artisan companies, more than half of which exclusively serve Brunello Cucinelli, supporting over 7,100 employees in these collaborative ventures.
This is an example of a core holding that goes a step beyond simple oversight. Brunello Cuccinelli adds tangible value, and has a positive impact on employees and the broader community in which it operates.
For more information on fashion and sustainability, read the latest article on Coats Group
Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.