QUICK Q&A: Global Small Caps

By USAA Investments

Some thoughts on the current appeal of non-U.S. small caps from the portfolio team at Lazard Asset Management, one of the subadvisors to the USAA International Fund (USIFX).

Their view in a nutshell: They believe global small caps are a better deal than the Russell 2000.

Is now a good time for non-U.S. small caps?

Much has been written about the expensive nature of small cap stocks especially as a result of their recent strong performance. While we would agree that this is true, it is largely confined to the U.S. Small cap stocks outside the U.S. continue to enjoy a significant multiple discount and are no more expensive than they were four years ago. Growth provides an even stronger case for EAFE small caps, as non-U.S. stocks run up over the past three years. More accommodative monetary policies and favorable currency trends help to support the growth estimates. And as the chart below shows, over the longer term, developed-market small caps have outperformed both DM large caps and U.S. small caps.

Is there a quant opportunity for global small caps?

We find that small capitalization stocks are an especially fruitful area for quantitative investors. The MSCI global small cap benchmark is comprised of more than 2,200 companies across 20 markets with market capitalizations ranging from $10 billion to as little as $50 million. The vast majority of stocks are in the $100 million to $2 billion range, which are liquid and tradable. They typically are not well covered by the analyst community, as they are generally too small to make a significant influence on an institutional portfolio. Information flow about these companies is typically less frequent and widely disseminated, creating inefficiencies in pricing.

But there are also the risks, right?

There tends to be a higher degree of company-specific risk in the non-U.S. small caps, which can impair results of a concentrated equity portfolio in the near term. Given the number of opportunities and poor coverage, it is also challenging to develop a comprehensive understanding across companies. In our case, systematic processes allow for comparisons across industries and markets in a disciplined fashion. We work to quickly analyze large amounts of financial and market information in order to make decisions about the attractiveness of any particular opportunity. This helps us construct diversified portfolios with large numbers of stocks across sectors and countries.

Quick Q&As with the other subadvisors to the USAA International Fund:

Quick Q&A: International Value (March 9, 2018)

Quick Q&A: International Equities (January 24, 2018)

 

 The Russell 2000 Index is a market capitalization-weighted benchmark index designed to measure the performance of U.S. small-cap stocks. It is made up of the 2,000 smallest U.S. companies in the Russell 3000 Index.