Putting International Small-Caps On the Map
Our goal in this paper is to provide an introduction for asset allocators to the international small-cap asset class by detailing its attributes in terms of performance, volatility, correlation, and fundamentals.
Because asset allocators often compare international small-cap with international large-cap, we thought it was particularly important to examine the long-term relative performance of these two asset classes to highlight the regular frequency with which international small-caps outperformed their large-cap siblings.
Knowing that the risk/return trade-off is always relevant when analyzing different asset classes, we also include volatility comparisons which show that international small-cap’s superior performance record came with less incremental volatility than many financial professionals might expect.
We then go on to examine how the two asset classes fared in different market environments, such as rising and falling equity markets and rising and falling interest rates periods, which showed that certain periods resulted in even wider positive relative return spreads for international small-caps.
To enhance international small-cap’s attractive attributes on a standalone basis, we demonstrate the benefits of adding the asset class to a global multi-asset portfolio. International small-caps have historically had a lower correlation to U.S. large-caps than either international large-caps or U.S. small-caps. This lower correlation allowed international small-caps to be additive on both an absolute and risk-adjusted return basis to a global multi-asset portfolio.
Finally, we look at some indicators that suggest, at least to us, why the current period offers a compelling and timely opportunity. We conclude by highlighting some fundamental factors that we believe make the asset class potentially fertile ground for active management.
Introducing a Large Opportunity in International Small-Caps
Considering that less than 1%1 of mutual fund assets in the U.S. are invested in small-caps outside the U.S., we suspect that many asset allocators think of international small-caps (if they think of them at all) as a nearly indistinguishable subset of the large non-U.S. equity universe. If this is correct, international small-caps would seem to be facing an uphill climb toward recognition as an accepted asset class, much like their stateside cousins did more than two decades ago. However, the facts tell a story that should level that hill. Many asset allocators will be surprised to learn that the total market value of the companies in the MSCI ACWI ex USA Small Cap Index, our proxy for international small-caps, is twice as large as that market capitalization of the Russell 2000 Index.
1 Source: Morningstar
Compared with U.S. small-caps, there are:
Source: FactSet as of 12/31/19 ”U.S. Small-Cap” is represented by Russell 2000, and “International Small-Cap” by MSCI ACWI ex USA Small Cap .
Continue reading here.
