Darnel Bentz on Quality Small & Mid-Cap Investing

Investing in small- and mid-cap companies is often seen as a high-risk, high-reward proposition. I see it differently. Working for a firm that has more than 30 years’ experience focusing on this space, we’ve developed investment strategies that seek to capture the growth potential of smaller companies while managing volatility in a disciplined, systematic way. 

Our approach begins with focus. Rather than owning hundreds of names and diluting exposure across positions, we typically hold between 30 and 40 stocks in our small- and mid-cap portfolios. This concentrated approach requires that each company meets rigorous quantitative and qualitative standards. We are looking for businesses with high returns on invested capital, low debt, consistent earnings, and strong free cash flow. We also evaluate management teams carefully, ensuring they are aligned with shareholders and capable of making thoughtful strategic decisions that preserve long-term value. 

We seek business models with sustainable characteristics, those with competitive advantages that allow growth to persist over extended periods. Interestingly, our small- and mid-cap portfolios often exhibit risk metrics like large-cap portfolios. We believe this approach demonstrates that high-quality small- and mid-cap investing, when executed thoughtfully, does not have to carry the extreme volatility often associated with these market segments. 

The fundamentals we prioritize in smaller companies are like what we look for in large-cap investments. Management alignment, capital allocation, competitive protections, and strong free cash flow are essential regardless of size. What differs is our attention to leverage and debt structure. Smaller businesses often rely more on floating-rate or shorter-term debt, making it critical to ensure they can fund growth internally through free cash flow generation and withstand economic stress when debt markets tighten up and restrict growth of leveraged businesses. 

We integrate small- and mid-cap exposure across client portfolios because, in our view, these segments provide a fertile opportunity for long-term growth. Recent years have presented a challenge: fewer small- and mid-cap companies are going public, and many stay private longer. When they do go public, they tend to debut at larger market…