Non-U.S. small caps: Strong start…but can it last?

Written by: Global Thought Leadership | June 16, 2017

Source: Bloomberg, as of 6/9/17.  Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

The Bottom Line

  • Global small caps, excluding those in the United States, are on a tear this year.
  • In fact, the Russell Global ex-US Small Cap Index sported a total return of 15.08% through June 6th compared with 5.32% for the Russell 2000 Index (both measured in US dollar terms).1
  • Yet over the past 10 years, U.S. small-caps have outperformed by a wide margin. At the end of the first quarter, the 10-year annualized return of the Russell Global ex US index lagged the Russell 2000 by over 400 basis points, two standard deviations below the mean.
  • What's striking about it: there could be much more room to run. Here's why: for the performance relationship between the two indexes to revert to the long-term average, it would require even more outperformance by small-caps outside the U.S.—either by a short-term jump, or a more moderate trend for a longer period of time.
  • It remains to be seen whether or not either will occur. But a global allocation to small-cap equities has possible benefits beyond the potential growth inherent in smaller companies, potentially including portfolio diversification and even competitive income.
  • Historically, non-U.S. small-caps have been effective diversifiers for U.S. large- and small-cap stocks: as of 5/31/17, the 10 year correlation of monthly returns of the Russell Global ex-US Small Cap Index to the S&P 500 and Russell 2000 indexes was 0.78% and 0.60% respectively.
  • And given the much broader opportunity set outside of the U.S., finding small companies that offer attractive dividend yields could be easier to do: as of 6/09/17, the dividend yield of the Russell Global excluding US Small Cap Index was 2.34% compared with 1.96% for the S&P 500 and just 1.43% for the Russell 2000.
  • Active managers could have a distinctive advantage when it comes to global small-caps—that’s because information about the companies is not as readily available as it is with larger ones, providing active managers with more opportunities to identify undervalued companies overlooked by others, and not included in standard indexes.

1 Sources for all data: Bloomberg; Royce & Associates.

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