Overlooked and outperforming: Canadian small caps

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ClearBridge sees Canadian small caps not as speculative bets but as global compounders trading at a discount

THEY MAY be labelled “small,” but the companies inside Franklin ClearBridge Canadian Small Cap Fund are anything but minor players. “These are really good-quality businesses that are leaders in their respective industries,” says portfolio manager Mike Richmond. “They’re disruptors. They’re innovators. And we believe they’ve got long runways to reinvest capital at returns well above their cost of capital.” That quality, however, is flying under the radar, especially in Canada, where small caps are often seen as synonymous with limited growth or domestic risk. Richmond says that perception misses the mark. “Only about a third of the revenues in our fund are Canadian. These are global

Franklin Resources, Inc. is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers specialization on a global scale, bringing extensive capabilities in fixed income, equity, alternatives, and multi-asset solutions. With more than 1,300 investment professionals and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and approximately US$1.6 trillion (approximately CAN$2.2 trillion) in assets under management as of January 31, 2024.

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Rolling 1-yr Beta vs. s&p/tsx small cap index

6/30/2022

“Small caps are often misunderstood as being more volatile, or overly tied to the Canadian economy. But for many of the companies we hold, their success isn’t dependent on supportive policy or domestic growth”

Michael Shaw, Clearbridge Investments

companies. Many generate more revenue from the US than from here at home.” While trade tensions and macro headlines dominate the front pages, Richmond and his co-manager, Michael Shaw, are taking a different view. They see the volatility and the valuation gap between small and large caps as an opportunity. “These companies are trading at significant discounts to their larger-cap peers,” Richmond says. “We don’t think that’s sustainable. And the market’s waking up to it. We’re seeing a real pickup in M&A activity; US strategics, private equity, all looking north.”

Despite their global footprints and leadership within their sectors, small-cap companies remain underrepresented in investor portfolios and Canadian indices. That misalignment is part of what drives the ClearBridge strategy. “Small caps are often misunderstood as being more volatile, or overly tied to the Canadian economy,” says Shaw. “But for many of the companies we hold, their success isn’t dependent on supportive policy or domestic growth.” In fact, Richmond points out, some of the fund’s core holdings – like ATS Automation, Kinaxis, and Descartes – are premier operators driving high returns in niche markets like logistics tech, supply chain automation, and fintech. “These aren’t speculative businesses,” he adds. “They’re quality compounders.” For years, global equity flows have followed a familiar playbook: pile into the US and leave the rest behind. But that trend is showing signs of fatigue, and Canadian small caps are starting to benefit from the reversal. “There’s obviously shifting expectations about where global equity markets are headed,” says Shaw. “We’ve been living through this American exceptionalism trade – everything flowing into US equities. But that’s started to change.” In the past 12 months, the ClearBridge team has seen a clear uptick in interest, both from institutional allocators and retail investors. Flows into their fund have been positive, echoing a broader trend of money rotating back toward international and small-cap exposures. “It’s not just sentiment,” Shaw adds. “We’re seeing capital come in from private equity and US strategics. When buyers with that kind of diligence are putting money to work in Canadian companies, it’s a strong signal. It tells us others are starting to see the same value we do.”

Shaw and Richmond have no illusions about the challenges of small-cap investing, especially in a noisy macro environment. The team’s strategy starts with identifying businesses that generate high returns on invested capital, have solid capital structures, and are run by aligned, capable management. “We’re fundamental equity analysts first,” says Shaw. “We spend our time trying to understand the businesses, not just the quarterly headlines.” That discipline extends to portfolio construction. The fund typically operates at a beta of below 0.85 relative to the small cap index – a reflection of its lower volatility compared to the index. Coming into 2024, the team took an even more cautious stance, starting the year below their typical beta range. But as the market sold off, they saw opportunity in some of the sectors hardest hit.

“There was broad-based, undiscerned selling,” says Richmond. “High-quality names were getting sold down alongside the weaker ones. We saw that as an opportunity to buy risk selectively, adding in areas like fintech, IT, and cyclicals that were unjustly punished.” Shaw underscores the point with a recent observation: after meeting with a series of Canadian industrial small-cap management teams, the tone was far more upbeat than what one might expect from reading the headlines. “These companies aren’t seeing an economic cliff,” he says. “In fact, many are worried about labour availability because demand remains strong.”

“High-quality names were getting sold down alongside the weaker ones. We saw that as an opportunity to buy risk selectively, adding in areas like fintech, IT, and cyclicals that were unjustly punished”

Mike Richmond, Clearbridge Investments

While the portfolio is driven by bottom-up fundamentals, Richmond and Shaw are cautiously optimistic that Canada’s policy environment may finally be turning more investment-friendly. “We’ve spoken to Canadian energy and industrial companies that are willing and eager to be part of this process,” says Shaw. “They’re not getting out over their skis, but they are genuinely excited about what’s coming out of Ottawa, and they’re ready to play their part.” “There’s been a real change in tone,” agrees Richmond. “The new government under Carney seems more focused on wealth creation, rather than redistribution. That’s a welcome shift.” Shaw points to long-awaited infrastructure and energy projects like LNG Canada and Coastal GasLink as signs of the potential opportunity. “These projects took years to approve, but they’re now at the execution stage, and they could have a real impact on natural gas pricing in Western Canada,” he says, highlighting holdings like Kelt and Topaz as potential direct beneficiaries. Even more broadly, both managers sense a growing political appetite for nation-building and see Canadian small caps as well-positioned participants in that effort.

Shaw agrees. “We’re not chasing the momentum. We’re building a portfolio of long-term compounders, and this is a market where the patient investor can still win.”

A 3D hand points to a glowing investment diagram

Investing through the noise

Policy shift, portfolio tailwind

Published August 11, 2025

Franklin ClearBridge Canadian Small Cap Fund – Series F

Canada Fund Canadian Small/Mid Cap Equity Category

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Source: Morningstar, as of June 30, 2025

A misunderstood corner of the market

In 2024, the Franklin ClearBridge Canadian Small Cap Fund earned the Lipper Award for best Canadian small cap fund over a three-year period, recognizing its top-tier risk-adjusted returns. For Richmond, the strategy’s success boils down to two enduring advantages: “We have an analytical edge through our proprietary research and a behavioural edge through our time horizon. We’re focused on compounding.” That long-view discipline – what Richmond calls “time arbitrage” – has become their signature. “Markets are short-term by nature. But we’re not. That allows us to lean in when others panic and to hold onto quality through cycles.”

Important legal information This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market. Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp. Additional information on Lipper Award: Franklin ClearBridge Canadian Small Cap Fund was awarded the 2024 Lipper Fund Award in the Canadian Small/Mid Cap Equity category for the three-year period ending September 30, 2024, out of a total of 167 funds. The Lipper Fund Awards, granted annually, highlight funds and fund companies that have excelled in delivering consistently strong risk-adjusted performance relative to their peers. The Lipper Fund Awards are based on the Lipper Leader for Consistent Return rating, which is a risk-adjusted performance measure calculated over 36-, 60-, and 120-month periods. The highest 20% of funds in each category are named Lipper Leaders for Consistent Return and receive a score of 5, the next 20% receive a score of 4, the middle 20% are scored 3, the next 20% are scored 2, and the lowest 20% are scored 1. The fund with the highest Lipper Leader for Consistent Return (Effective Return) value in each category wins the Lipper Fund Award. Lipper Leader ratings change monthly. For more information, see lipperfundawards.com. Although Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Lipper. Performance for the fund for the period ended September 30, 2024, is as follows: 23.41% (1 year), 7.83% (3 years), 10.08 % (5 years), 0.11% (10 years), and 5.81% (since inception on November 24, 2000). The corresponding Lipper Leader ratings of the fund for the same period are as follows: N/A (1 year), 4 (3 years), 5 (5 years), 4 (10 years). Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.

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