Asset Management. European Small and Mid Caps Only Those Who Look Closely Are Able to Unearth True Market Potential

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Asset Management

European Small and Mid Caps – Only Those

Who Look Closely Are Able to Unearth True

Market Potential

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Many experts agree that equities will remain the preferred asset category over the long term. This view is underpinned by the ongoing economic recovery that has also extended to periphery countries in Europe. Moreover, the risk of a eurozone breakup has further diminished. This could give markets an important boost in terms of momentum. A selective investment approach is called for, however, in view of the higher valuations and expected spike in volatility. One segment that is often overlooked in favor of multinational conglomerates is small and mid caps – unjustly so since these local champions generally outperform their large cap counterparts in the long run. Within the equity asset category, we favor European stocks from a geographical perspective. Thanks to the economic recovery, earnings in Europe – albeit at a low level – should benefit from disproportionately strong upward revisions. In addition, European equity markets remain fairly valued despite the protracted bull run. This underpins our positive view on European equities, particularly for small and mid caps.

With roughly 5,000 stocks, the European small and mid cap segment is highly fragmented and only inadequately covered by analysts. This results in market inefficiencies, which means the current share price may often deviate considerably from the fair value. This segment requires an exorbitant amount of analysis to identify attractively valued stocks. On the other hand, inefficient markets open up opportunities for experi-enced portfolio managers with close contacts to company management to generate attractive additional returns through active stock selection.

Attractive investment strategies

Credit Suisse provides attractive investment solutions to inves-tors in the European small and mid cap segment. We offer two distinct strategies to meet investors’ various needs.

ȩ Long-only equity funds

We have just the right investment solution for investors betting on rising share prices and interested in participating in the European economic recovery with small and mid caps – namely, traditional long-only equity funds. Based on various studies, the small and mid cap segment is highly attractive, particularly in the long run. According to a recently published study, during the period from 1926 to 2013 the price performance of small cap stocks clearly exceeded that of

Summary

The European small and mid cap stock segment offers attractive investment

opportunities, as well as the chance to capture additional return. Moreover,

this segment should perform particularly well in the current economic

recov-ery phase in Europe.

large cap stocks in most countries. In the UK, for example, the performance of small caps averaged 15.5% per year compared to a 12.6% return on large caps during this period. With an actively managed long-only strategy, investors can exploit this small cap effect while benefiting from the valuation inefficiencies of this equity segment.

ȩ Long/short equity funds

For investors who wish to invest in small and mid caps but are unwilling to take on the full market risk, long/short equity funds represent an attractive investment option. These strategies allow portfolio managers not only to buy undervalued stocks but also to short sell overvalued stocks and thereby bet on falling share prices. Short selling reduc-es the volatility of the overall portfolio and enablreduc-es invreduc-estors to benefit from valuation inefficiencies of the small and mid cap market without having to bear the full market risk. With actively managed long/short strategies, investors can remain fully invested in equities – irrespective of the market phase – without having to worry about the right timing as these decisions are left to the portfolio managers. Long/ short equity funds offer a particularly attractive investment option in sideways trending markets with an inherent risk of corrections.

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Except for the interruption in 2011, equity markets have been in an upward trend since 2009. For many investors, this situation raises the question: Are valuations slowly becoming stretched – or are we likely to see a continuation of the bull run? Bond markets offer few if any alternatives, however, given that the expected normalization of monetary policy is associated with rising interest rates.

Most financial experts agree that equity markets will continue their upward trend in the long term. This view is underpinned by the increasingly broad based economic recovery that has also extended to periphery countries in Europe. Based on the market outlook of our own experts, economic data for Europe should continue to improve. We expect a sustained recovery of both the business and consumer climate. In European periph-ery countries, credit conditions for small and medium sized enterprises (SMEs) should continue to ease thanks to mark-edly lower yields on government bonds, as well as banks’ stronger balance sheets. Moreover, the risk of a eurozone breakup has further diminished. This could give equity markets a major boost.

Europe is the preferred investment region

Within the equity asset category, we favor European stocks from a geographical perspective. With the region failing to fully keep up with the performance of US equities in 2013 (S&P 500: 26.9%, MSCI Europe: 21.6%) and still trading below its highs from 2007, we believe that European stocks

have the edge in terms of higher growth potential in 20141_.

Thanks to the economic recovery, earnings in Europe – albeit at a low level – should see disproportionately strong upward revisions going forward. In addition, European equity markets still have respectable valuations despite the protracted bull run. This underpins our positive view on European stocks, particu-larly for small and mid caps, which also extends to non-Euro-pean stocks characterized by a strong focus on Europe. Swiss equities, in particular, also stand to benefit from the apprecia-tion of the US dollar that we expect to see.

European Small and Mid

Caps Benefit from the

Economic Recovery

ȩ Small and mid cap companies should perform particularly

well in the short term against the backdrop of an increas-ingly broad based economic recovery in Europe.

ȩ For structural reasons, the small and mid cap segment

should also earn a higher return than large caps in the long term.

1_{Historical performance indications and financial market scenarios are not reliable indicators of}

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Small and mid caps for the current economic phase

However, the markets have entered a phase of high volatil-ity and increased equvolatil-ity valuations. For this reason, a selec-tive approach using the right strategy is paramount to achieving investment success. Investing off the beaten path allows investors to tap into highly attractive equity niches – such as the often overlooked European small and mid cap segment. This segment comprises roughly 5,000 stocks and is currently trading at a premium of 15% over large caps, consistent with its historical average. In contrast to large caps, however, small and mid cap stocks exhibit better earn-ings momentum. In addition, these companies typically show a disproportionately strong performance relative to large cap stocks during periods of economic recovery. This is primarily due to the fact that, during economic downturns and upturns, investor risk appetite tends to decrease or increase, respectively. If risk appetite increases during phases of eco-nomic recovery, demand for less liquid stocks – i.e. those of small and mid caps – will rise accordingly.

Small caps outperform large caps over the long term

Equities with relatively small market capitalization offer better value and are likely to outperform the overall market not only in the short term but also in the long run. This outperformance is corroborated by numerous studies, such as the study by Nobel Prize in Economics recipients Fama and French from

Fig. 1: Small and mid caps in Europe

In Europe, small and mid caps have outperformed large caps over the past five years – i.e. following the post financial crisis low.

Source: Bloomberg As of April 30, 2014

Historical performance indications and financial market scenarios are not reliable indicators of current or future performance.

1992 and 1993.2_{These findings have been confirmed by}

recent financial publications as well. As documented in the

Credit Suisse Global Investment Returns Yearbook 20143_,

small cap stocks outperformed their large cap counterparts over the longer period of 1926 to 2013. This is most impres-sively demonstrated by a comparison of the average return per year in the US (large caps: 9.9%/small caps: 12.4%), as well as in the UK (12.6% and 15.5% respectively). Indeed, the small cap effect can also be observed in most other coun-tries, with a particularly pronounced effect in Switzerland for example.

From a structural point of view, the evolution of this investment style is positively influenced by the following factors:

ȩ Stocks of small and mid cap companies are for the most part

less liquid than those of large caps. The typically higher risk of an investment in small and mid cap stocks is reflected in higher risk and liquidity premiums and has a positive effect on performance over time.

ȩ Small and mid caps are often companies in the growth phase

of their business cycle. They occupy high-margin niches as they frequently bring new, innovative products and services to the market. Accordingly, they are in a position not only to quickly tap into new markets and customer segments, but also to achieve stronger long-term growth than major com-panies, which already sell their products on a global scale.

2_{Eugene F. Fama, Kenneth R. French: The Cross-Section of Expected Stock Returns. In: Journal of}

Finance. 47, no. 2, 1992, pp. 427–465, and Eugene F. Fama, Kenneth R. French: Common Risk Factors in the Returns on Stocks and Bonds. In: Journal of Financial Economics. 33, no. 1, 1993, pp. 3–56.

3_{Elroy Dimson, Paul Marsh and Mike Staunton in Credit Suisse Global Investment Returns Yearbook}

2014, p. 42 ff.

Fig. 2: Small cap premiums in 23 countries

In the past, investments in small caps achieved higher returns than invest-ments in large caps. This small cap premium can be observed in most countries over time.

Source: Credit Suisse Global Investment Returns Yearbook 2014 As of December 31, 2013

Historical performance indications and financial market scenarios are not reliable indicators of current or future performance.

MSCI Europe Large Cap MSCI Europe Mid Cap MSCI Europe Small Cap Apr

09 Aug09 Dec09 Apr10 Aug10 Dec10 Apr11 Aug11 Dec11 Apr12 Aug12 Dec12 Apr13 Aug13 Dec13 Apr14 80 100 120 140 160 180 200 220 240

Average premium per month (long term) Average premium per month (2000–2013) -0.4

NOR DNK NZL ITA NLD ZAF ESP SWE UK BEL CHN DEU i. D. US CHE RUS CAN AUS JPN PRT AUT FRA 0.4

0.8 1.2

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Most financial experts expect equity markets to continue their upward trend over the long term, supported by an increas-ingly broad based economic recovery. However, the risk of corrections will also increase should corporate earnings fail to catch up with already significantly higher share prices or should the geopolitical situation worsen.

For investors betting on rising European equity markets,

long-only equity funds represent an attractive investment option.

These traditional investment vehicles enable investors to exploit the short-term above-average upside potential of small and mid cap equities, which should perform particularly well in the current economic recovery phase. An investment in this strategy also holds out the prospect of excess return in the long term as small and mid caps boast clear structural advan-tages over their large cap counterparts.

Long/short equity funds are an attractive investment

solu-tion for investors who shy away from assuming the full risk of equity markets or who also wish to earn positive returns in sideways trending markets with an inherent risk of corrections. Long/short strategies allow portfolio managers not only to buy stocks they feel have the best upside potential but at the same time to short sell stocks whose future price performance they see as below average.

Although long/short strategies are typically also positioned net long the equity market and thus stand to benefit from the long-term upward trend in equity markets, due to short selling they are less exposed to the general market trend. Over the short term, a portfolio manager can also take a net short position to bet on a negative performance of the market segment, thereby profiting from price corrections in small and mid cap stocks. As a rule, these investment concepts are designed to achieve a positive absolute performance across different market phases. These absolute return approaches differ from 130/30 strate-gies, which allow short selling in equities of up to 30% of the fund’s net asset value and are therefore also classified as long/short equity funds. In contrast to pure long/short funds, 130/30 strategies employ a relative investment approach and are fully exposed to market risk at all times.

The support of investment specialists is recommended

Most companies in the small and mid cap segment have a strong focus and specialize in their respective niche markets. Investments in this equity segment thus require an exorbitant amount of analysis and an adequate level of portfolio diversifi-cation. For this reason, we recommend investing in the small and mid cap segment via broadly diversified investment prod-ucts together with the support of proven investment experts. A distinctive aspect of the small and mid cap stock segment is its high degree of fragmentation. The sheer overwhelming number of small and mid cap companies in Europe is one reason why they can be covered by only few analysts. The lack of information often results in inefficiencies in these markets, which means the market value of a stock will deviate from fair value with greater frequency. This contrasts with blue chip markets, which are more efficient due to higher analyst cover-age and can therefore also be replicated by passive invest-ments.

The inefficient small and mid cap markets open up opportuni-ties for portfolio managers to deliver alpha through targeted individual stock selection, whereby the smaller the company – and the smaller the number of analysts covering it – the higher the alpha that is able to be generated. Portfolio managers that maintain close contact with company decision makers and meet with them several times a year possess the requisite knowledge to determine fair value for the company.

Fig. 3: Alpha generation through active management in inefficient markets

Sources: Research Affiliates, Credit Suisse

Two Distinct Investment

Concepts Enable Investors

to Exploit the Potential of

Small and Mid Caps

Authors: Dr. Anja Hochberg, Chief Investment Officer Western Europe & Switzerland, Olivier P. Müller, CFA, Sector Head, Research

-30% -20% -10% 0% 10% 20% 30% Efﬁcient market – Large Caps Market prices match the true fair value

Market prices drift away from their true fair value

Inefﬁcient market – Small and Mid Caps

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Our Investment Solutions

Are you interested in investing in the high growth European small and mid cap segment? We would welcome the opportu-nity to present you with our traditional equity funds (long-only strategies) and long/short equity funds designed to suit your needs.

Long-Only Strategies

Credit Suisse Equity Fund (Lux) Small and Mid Cap Europe

This equity fund aims to achieve the greatest possible capital growth by investing in undervalued stocks of small and mid cap companies in EU and EFTA countries that have a maxi-mum market capitalization of EUR 5bn. The fund’s investment universe comprises an estimated 5,000 stocks. The fund management team selects approximately 80 to 120 stocks based on a comprehensive country, sector and company analysis.

Fund currency EUR

Swiss security number EUR share class B:

EUR share class I: 1401681057934 Cumulative 5-year performance

(net)4

EUR share class B: 141.6% Lead portfolio manager’s

investment experience in years 17

Credit Suisse Equity Fund (Lux) Small and Mid Cap Germany

This equity fund aims to achieve the greatest possible capital growth by investing in select German small and mid cap stocks. Its investment universe comprises an estimated 500 stocks. Based on its own in-depth research, the fund man-agement team selects approximately 85 stocks distinguished by high innovation power, solidity and quality. The fund has been repeatedly recognized with prestigious awards.

Fund currency EUR

Swiss security number EUR share class B: EUR share class EB: EUR share class I:

248590 11154337 1057945 Cumulative 5-year performance

(net)4

investment experience in years 14

4_{May 31, 2009 to April 30, 2014.}

Historical performance indications and financial market scenarios are not reliable indicators of current or future performance. The net performance data do not take account of entry or exit charges.

Credit Suisse Asset Management boasts proven expertise in the European small and mid cap segment. The team, headed by Felix Meier, has a highly stable composition and longstand-ing experience in this demandlongstand-ing segment. Currently, the team is responsible for actively managing four long-only equity funds and two long/short equity funds.

European sector specialists

European small and mid cap portfolio managers

Our Investment Expertise

Jan Berg

Small Caps Europe

17 years’ investment experience

Felix Meier

Small Caps Germany

Patrik Carisch

Small Caps Switzerland 28 years’ investment experience

Marcel Schibli

Plinio Zanetti

Patrick Fehr

Telecom, Technology & Commodities 12 years’ investment experience

Julio Alberto Giró

Healthcare, Utilities & Industry 20 years’ investment experience

Nicola Nolè

Financials

Jana Schenker

Consumer Discretionaries, Consumer Staples 8 years’ investment experience

Aude Scheuer

Energy

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Credit Suisse Equity Fund (CH) Small & Mid Cap Switzerland

This equity fund aims to achieve the greatest possible capital growth. To this end, the fund management team, which boasts a successful track record, invests in undervalued stocks of small and mid cap Swiss companies typically distin-guished by attractive valuations, good positioning in the mar-ket and a high level of management quality.

Fund currency CHF

Swiss security number CHF share class B:

CHF share class I: 16321420892699 Cumulative 5-year performance

(net)4

CHF share class B: 90.2% Lead portfolio manager’s

invest-ment experience in years 28

Credit Suisse Equity Fund (CH) Swiss Small Cap Equity

This fund aims for long-term capital growth at a controlled risk level. The fund invests in stocks of Swiss small cap compa-nies distinguished by solid balance sheets, robust cash flows and high growth rates. The investment universe comprises roughly 230 stocks. The fund typically invests in 50 to 70 individual stocks.

Fund currency CHF

Swiss security number CHF share class A: CHF share class D: CHF share class I:

(net)4

CHF share class A: 122.5% Lead portfolio manager’s

Long/Short Strategies

Credit Suisse SICAV One (Lux) Small and Mid Cap Alpha Long/Short

This equity fund invests in European small and mid caps and employs a directional long/short strategy. This fund actively exploits alpha opportunities while at the same time retaining the flexibility to reduce market risk by short selling. The objec-tive is to construct a portfolio with lower volatility, a lower correlation to equity markets and better risk-adjusted perfor-mance relative to long-only funds.

Fund currency EUR

Swiss security number CHF share class EBH: CHF share class R: CHF share class S: EUR share class B: EUR share class I: USD share class R:

23786573 11514130 11514155 11514102 11514128 11514152 Cumulative 3-year performance

(net)5

invest-ment experience in years

14

Credit Suisse Select Fund (CH) Swiss Equities 130/30

This is a highly actively managed Swiss equity fund investing in stocks included in the Swiss Performance Index. The fund allows short selling in equities of up to 30% of its net asset value. A portion of the proceeds is used to increase the weigh-ting of exisweigh-ting equity positions or to initiate new positions in the portfolio. The fund uses this flexibility to achieve the high-est possible outperformance relative to its benchmark.

Fund currency CHF

Swiss security number CHF share class B: CHF share class D: CHF share class EB:

(net)4

CHF share class B: 102.3% Lead portfolio manager’s

4_{May 31, 2009 to April 30, 2014.} 5_{May 31, 2011 to April 30, 2014.}

Historical performance indications and financial market scenarios are not reliable indicators of current or future performance. The net performance data do not take account of entry or exit charges.

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