Lex Hall: Hello, and welcome to the Morningstar series, "How We Invest Your Money." I'm Lex Hall and today I'm joined by Ned Bell from Bell Asset Management. We are going to talk about the outlook for 2019 and also finding value in global small and mid-cap stocks.

Hi, Ned.

Ned Bell: Hi, Lex. Thanks for having me.

Hall: Thank you. Thank you for coming. Let's start with 2018. It was a bit of a rough year in general for stocks. The S&P, for example, 500 fell 9 per cent in December alone. But you guys came out of it pretty well. You had a pretty good year. You had 75 per cent of your holdings outperforming. Where did you see the gains?

Bell: Yeah, that's right. So, we did have a good year in what was obviously a pretty difficult time period. I'd break it down into two sections; the first nine months of the year, so the lead-up to the Q4 drawdown, we had good returns coming across consumer staples, consumer discretionary and also in some of the small and mid-cap names. So, we had good gains there. And then, I think in Q4, we managed to avoid a lot of the sectors that got hit particularly hard, especially in tech. So, having taken profit there earlier in the year really set us up well for the end of the year period. It was really stock election is what helped us rather than our geographical widening or anything else. So, as you said, 75 per cent of our stocks did well So, the batting average was good. Dropping down from that, we saw most of our gains coming from consumer discretionary, consumer staples and healthcare stocks. So, companies like Hershey, WD-40, great performers, as well as the companies like AMBU, Mettler Toledo. So, not necessarily household names, but ones we found really interesting. They were really the big drivers throughout 2018.

Hall: Okay. Now, you recently said that the end of last year that we talked about, that 9 per cent fall, you described it as a wake-up call, and you say that we can expect what you call an Act 2 that is more turbulence in 2019. What are you anxious about?

Bell: Yeah. So, there are a couple of things I'm anxious about one being valuations amongst large-cap growth stocks are right back to where they were in September. So, MSCI World Growth Index is trading on 19.5 times forward-looking earnings against the backdrop of global economic growth slowing quite quickly. Obviously, the Fed has done a complete backflip in terms of their approach to rising interest rates. And so, it's when you combine that valuation risk with a softening economic and earnings environment is where I start to get a little bit nervous about markets per se. Having said that, as an active manager that creates fantastic opportunities, because you start to see stocks get oversold like we saw in Q4. So, as a bottom-up patient investor, we are really actually quite excited about the period that's coming up.

Hall: Okay. And in that light what sort of repositioning are you doing? Where are you taking profits?

Bell: Yeah. So, what we've been doing in the 12 months up to, again, September last year, we took a lot of money out of the tech, specifically large-cap tech. And from a market cap perspective, we've been gradually pushing more and more of the portfolio into small and mid-cap stocks. So, reducing our exposure to those big technology companies, the Microsofts, the Apples of the world and finding small and mid-cap companies. As a sub-asset class, small- and mid-cap stocks are trading on about 16.5 times forward-looking earnings and they have actually underperformed by about 80 basis points a year over the last five years. So, the gap between large-cap growth and small and mid-cap has really opened up. And so, we think that's a really compelling part of the market at the moment.

Hall: Okay. Let's shift gears a little bit and talk about the Bell Asset Management philosophy. I know you guys – you make a point of going out, doing your research and visiting companies. You've got quite a large staff and you go out and you talk to those companies. What are the kinds of things that you are looking for, what are the questions that your team members are asking when they go there?

Bell: Yeah. It's a really good question. We do about 500 research meetings a year with companies. It's understanding two things. One is the sustainability and the quality of the franchise that company has. And then, number two is, how the management teams are going to allocate capital. So, if we come across a company that's going to – we think they are going to grow aggressively through M&A, we typically stay well away. But if we look at a company like, especially in the small- and mid-cap space companies are more willing to invest in R&D to create more and more sales, that's what we really like. We like companies that invest in their franchise.

Hall: Okay. Well, Ned, thanks very much for your insights.

Bell: Pleasure. Thanks for having me.

Hall: I'm Lex Hall for Morningstar Australia. Thanks for watching.