Barings’ Nick Williams discusses the characteristics of the International Smaller Companies asset class, and explains why an active approach to investing in the sector best positions investors to generate attractive returns.
Investing in international small-cap equities offers a unique opportunity to gain exposure to a large investment universe of highly differentiated and idiosyncratic companies operating in niche market segments. The sector continues to generate increasing interest among investors and asset managers, with small/mid-cap funds seeing far greater inflows as a percentage of AUM over the past decade than larger funds. In this paper, we examine the relative risks and opportunities associated with smaller companies compared to their larger counterparts and detail how the long-term performance advantage and diversification benefits can help to optimize investors’ risk and return profiles.
The asset class is particularly well suited to active management. With more than 2,000 companies at the index level, the depth and widespread availability of research in the investment universe is rarely exhaustive, creating opportunities for focused active management, specifically bottom-up stock pickers, to add value in a way that more broad passive strategies cannot. Structured fundamental research and a bottom-up stock selection process are core to our approach at Barings, and we take advantage of the wide and diverse opportunity set to select our favored investment ideas. The large number of index constituents means that no individual company is regarded as a ‘must-hold’ for risk-reduction purposes, thereby allowing us to follow our conviction to build a portfolio of the best ideas for clients.
Small-Caps Have Performed Strongly
International smaller company indexes have tended to outperform their larger-cap counterparts over the long term, registering higher returns in 14 out of 19 calendar years since the turn of the century.
By their nature, smaller companies—typically defined as companies with market capitalizations of between $250 million and $6 billion, although the benchmark’s constituents currently range from about $100 million to $10 billion—may not enjoy the scale advantages of their larger counterparts, but it is precisely this smaller size that grants the asset class an inherent growth potential and performance advantage over the longer term.