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Staking a Claim Abroad: Exploring the International Small-Cap Market

Brown Capital Management is proving its mettle in the international space.

Editor's note: This article first appeared in the Q2 2021 issue of Morningstar magazine. Click here to subscribe. Pictured above: Maurice Haywood 

Undiscovered Manager is a regular profile of a noteworthy strategy that hasn’t been rated by Morningstar Research Services’ analysts.

With U.S. large-cap stocks topping the charts for the decade through 2020, the international small-cap market is one source for fresh opportunities. Do a fund screen in Morningstar Direct for promising leads, and Brown Capital Management International Small Company BCSFX lands near the top: It has been a standout in the foreign small/mid growth Morningstar Category.

If the name rings a bell, that may be because Baltimore-based Brown Capital Management has maintained its standing as an esteemed independent boutique for decades, even as many other small firms have been gobbled up in a consolidating industry. Founded in 1983 by Eddie Brown, the firm is among the most highly regarded and oldest African-American-founded asset managers in the U.S. “We have a place in history,” Brown says, explaining why he’s resisted offers to buy the firm.

Brown Capital also earns an Above Average Parent rating from Morningstar Research Services. Morningstar associate director Tony Thomas sums it up as a “solid, employee-owned investment boutique built around a strong flagship offering.” The flagship is a domestic-equity fund, Brown Capital Management Small Company BCSSX. It has a Morningstar Analyst Rating of Gold, and its management team was named Morningstar’s Domestic Stock Fund Manager of the Year for 2015.

That year also saw the launch of the International Small Company fund. Now with a strong five-year record on the books, this fund’s four-member team is getting noticed in its own right. The fund had net inflows of more than $600 million over the past year through February and now has more than $2 billion in assets under management.

Daniel Boston, Duncan Evered, Kabir Goyal, and Maurice Haywood build the portfolio by consensus. Their team dynamic came through in a recent interview: Although they all had a lot to say, they also carefully gave each other equal time. As Haywood put it, “There is no star system. It doesn’t matter whose idea originally got into the portfolio.”

Cross-Pollination
The international small company strategy follows the fundamental research process developed by Brown Capital president and chief investment officer Keith Lee for the U.S. small company strategy in 1992. As Brown Capital frames it, they seek “exceptional growth companies.” These are profitable businesses with differentiated products, strong competitive positions, and management that can deliver long-term growth.

One thing that distinguishes Brown Capital is that its definition of “small” hinges on revenue. The U.S. strategy has a target of no more than $250 million in revenue at the time of investment that was set when it opened 30 years ago, while the international version was launched with a limit of $500 million to account for inflation and foreign-currency movements.

“By looking at revenue rather than market cap, the managers are more likely to find companies with marketable products, instead of betting on firms that offer lots of promise but little in actual sales,” says Morningstar’s Thomas. “Brown Capital has a solid multiyear track record of finding small U.S. companies that often go on to become big winners, and it looks like they’ve effectively adapted it for overseas equity investing.”

Haywood, who was an investment analyst at Holland Capital Management when he “jumped at the opportunity to work at Brown Capital with Eddie Brown” in 2000, helped develop the small company international strategy. “Our hypothesis,” he says, “was that our domestic small company approach would travel well outside of the U.S.”

He notes that there is “cross-pollination” between the strategies. Companies in the different portfolios may be players and even competitors in the same industry, so the teams share insights.

Boston chimes in with an example: The international small company strategy owns Danish company Ambu AMBU B:DK, which makes disposable endoscopes, while its domestic sibling has shares of Cantel Medical CMD, which cleans reusable endoscopes. Both teams joined a recent call with a gastroenterologist to discuss the relative merits of these approaches.

Those examples underscore another similarity. Both teams invest for the long term; recent turnover was less than 20%. Cantel has been in the domestic portfolio since 2010 and Ambu in the international one since its 2015 inception. That means holdings may grow beyond traditional small-cap boundaries. The international team bought shares of MercadoLibre MELI, now the dominant online marketplace in Latin America, when its market cap was below $5 billion. They held it in the international small-cap fund until late 2020, when the market cap reached $85 billion.

Evered, who had been a portfolio manager at American Express Financial Advisors, joined Brown Capital to develop this strategy with Haywood in 2011. They started researching MercadoLibre that year, and he says it illustrates how the process should work: “You have to be early, you have to be right, and you have to invest enough to make a difference.” In this case, they did all three.


    Daniel Boston

Team of Equals
The portfolio is always concentrated in only about 45 companies. To justify their conviction, the four managers divvy up the portfolio to closely monitor the holdings and regularly rotate coverage to guard against biases. At Brown Capital, managers are generalists, ready to tackle anything.

Their collaborative approach depends on careful team building, which starts at the top at Brown Capital. Brown and Lee are involved in interviews from the beginning. Hiring candidates with the right experience is a must, but Brown believes it is just as important that candidates fit in with the firm’s collegial atmosphere.

“We do very important work, but we want to enjoy ourselves along the way,” Brown says. “This culture has been nurtured over the years; it’s not accidental.”

Evered agrees: “We like each other, to a person, all 36 of us. That is a tribute to Eddie.”

Evered and Haywood were mindful of the culture when expanding the international team. “We are independent thinkers with diverse backgrounds but a shared vision,” Haywood says. “With a team of four, you can have a spirited debate.”

Goyal, who joined the team in 2017, was a portfolio manager on Wasatch International Growth WIIGX when he got a call from a headhunter. “I wasn’t familiar with Brown Capital, but I brought up their holdings and it was spectacular to see the similarity in names.” The portfolio was more concentrated, which appealed to him, and the culture sealed the deal.

“I just took to them,” Goyal says. “It was quite an interesting interview process. Duncan and Maurice came down and said, ‘You have a gap in your schedule, and you don’t know Baltimore, so why don’t we drive you around town?’ They pointed out different neighborhoods and showed me where they lived.”

Also a Wasatch alumnus, Boston was a portfolio manager at Baird when he got the call in 2019. “I was incubating an international small-cap product, and Brown Capital was the only one that was comparable within the investment universe,” he recalls. “I said, ‘I don’t know who Brown Capital is by face, but I know them by the numbers and I’d love to talk to them.’”

The firm has maintained a sense of community through the pandemic by taking its monthly townhall gathering online. Meanwhile, the international team has kept its rhythm of weekly formal meetings and informal daily check-ins from afar—even Goyal, who moved with his family to Japan at the beginning of the pandemic to stay with his in-laws but works East Coast hours. “That’s probably the hardest adjustment,” he laughs. “My kids think I’m a vampire now!”

“They make a solid team,” says Ron Chen, a managing director in the investment office of The Rockefeller Foundation. “You can tell after meeting them that there are synergies with their different life experiences and personalities.”

Chen has followed Brown Capital since the mid-1990s, when he was an investment officer at the New York State Common Retirement Fund, which hired the firm in its early days as part of a program to support emerging minority and women managers.

“Diversity is not just the right thing to do,” Chen says. “It can improve performance as well. On our own investment team, 12 of the 13 people are women or people of color.”

The Rockefeller Foundation seeks out skilled managers with broad global mandates. “I’d kept an eye on Brown Capital since I left New York State,” Chen says, “and watched as the international team was built out. We hired them in March 2020, near the market bottom, and captured the full market rebound and then some.”


    Duncan Evered

Building Connections
The International Small Company fund’s 45.1% return in 2020 was outsized in absolute terms, but its position among the top performers in its category is customary. While the fund lagged in 2021’s first quarter, its long-term performance remains strong. From October 2015 through March 31, it has an annualized 19.3% return compared with 12.2% for its average category peer.

It’s worth noting that the team’s other charge, the all-cap Brown Capital Management International Equity BCISX, has a middling record, though that fund has undergone a renovation. It opened in 1999 and today has only $65 million in assets. While Haywood joined the fund’s previous managers in 2007, the strategy had more of a core orientation than a quality growth bent until 2019. Once the small-cap strategy hit its stride, the firm relaxed constraints that had limited overlap between the two strategies. Today, around one third of the team’s picks are in both portfolios—and MercadoLibre remains in the all-cap version.

In a typical year, members of the team will make about a dozen trips to visit management overseas, as well as meet with industry experts and user groups. They’ve continued this kind of research remotely and added five new holdings over the past year in the small company fund.

One of these is AJ Bell AJB:UK, which Boston calls a “scaled-down version of Charles Schwab” in the U.K. space. The firm has less than 2% market share, he says, “so there’s durability of revenue growth ahead.” The team was able to have a call with the founder and talk to advisors and clients. As with every stock considered for the portfolio, the team’s work culminated in a research report with an earnings model and valuation model, which kicked off a discussion to develop a consensus on whether and how to move forward.

Evered puts forth Abcam ABC:UK, which the international small company fund has owned since inception, as an exemplar. Founded by a Cambridge researcher who needed antibodies for his own research, the firm has a built a strong competitive position: Its e-commerce site is a differentiated model, and the company excels at logistics, enabling it to ship around the world quickly. Its growth rate is twice the industry’s, and it is taking share in a large market.

“They have an excellent management team and a business that provides resources to fund growth,” Evered says. “Our first work-from-home remote call was with their team,” Haywood recalls.

Goyal adds that their access was facilitated by relationships they had developed in person—such as the time they toured Abcam’s lab to see how the science worked, down to peering through a microscope at slides of brain tissue straight from the hospital morgue across the street.


  Kabir Goyal 

Protecting a Legacy
Stories like this illustrate how the portfolio is built, company by company. But there are guardrails in place. “We are trying to maximize our exposure to exceptional growth companies,” says Boston, “which implies a high level of idiosyncratic risk. Because we invest in a concentrated collection, we make sure we’re doing it in a risk-measured way.”

In practice, that means a limit of 33% in any one of six custom sectors: information/knowledge management, medical/healthcare, business services, consumer related, industrial products/systems, and miscellaneous. Individual position sizes start at 0.5% to 2.5% and are capped at 6%. The strategy isn’t hedged, but the team assesses any operational headwinds created by fluctuating currencies when evaluating a company.

These measures have helped keep the fund’s risk in line with more diversified peers. Its 5-star Morningstar Rating reflects high returns relative to its category over the past three and five years, with only average risk.

Wirecard WCAGY was a rare misfire last year, as evidence of accounting fraud led the team to decrease and finally sell the position. The damage was limited, as Haywood notes, yet he also says, “For us to print a number north of 40% in 2020 and then still have a Wirecard is a reminder of the importance of humility in this process.”

Avadel Pharmaceuticals AVDL is a more typical example of a company that no longer meets the team’s standards: Its thesis changed. The company had a unique delivery mechanism that it licensed to drug developers. When it pivoted to developing drugs in-house, Brown Capital sold the stock.

“We are not investing in companies that have binary outcomes,” explains Goyal. “If a company has a drug in phase 1 that makes it all the way, the stock will be 10 times higher. But if it doesn’t work, you end up with zero. That’s not our style.”

The firm is dedicated to protecting its style and expects to soft close the fund at $4 billion. In this case, too, the fund will follow in the steps of its better-known sibling, which closed to new investors in 2013. Chen cites that commitment as one reason he felt confident investing here.

Another plus, says Chen, is that Brown Capital is an employee-owned firm: “Their livelihoods depend on the performance they generate.” Thomas notes the employee stock ownership plan, put in place in 2016, as part of his positive assessment of the firm.

Brown says he started the plan to protect the firm’s legacy by retaining its talented teams. “It’s a culture that’s working,” he says, “and since 2016, I would say humming.”

Laura Lallos is managing editor of Morningstar magazine.

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