The Case for Active in International Small-Caps

The Case for Active in International Small-Caps

International small-caps have attractive attributes and active managers are well positioned to uncover the best that this underutilized asset class has to offer.


Here are some important reasons why:

A Large and Diverse Asset Class

There are more than twice as many international small-caps as domestic small-caps, providing ample opportunity for active managers to search for mispriced stocks. Further, international small-caps offer access to local, regional, and global businesses hailing from a diverse group of countries that collectively account for 75% of global GDP.

An Inefficient Asset Class

More than 34% of the companies in the Russell Global ex-U.S. Small Cap were receiving one or no sell-side analyst coverage versus 16% for those in the Russell 2000 as of 6/30/17 1. This provides an active manager with a potentially sizable analytic advantage.

High ROIC Companies

Historical returns of the international small-cap index’s high-profitability companies, based on return on invested capital (ROIC), have markedly exceeded those for the index as a whole. The average annual total return for the top ROIC decile of non-U.S. small-cap stocks was 12.1% from 7/31/96-6/30/17, compared to 6.4% for the overall index over the same period. This suggests to us that an active management approach focusing on companies with higher profitability and sustainability can enhance the potential for higher returns.

Companies with Earnings

Loss-making international small cap companies have historically lagged. In fact, companies with positive earnings have outperformed the international small-cap index, gaining 8.3% versus 6.4% on an average annual total return basis from 7/31/96-6/30/17. A manager who focuses on non-U.S. small-caps with established histories of earnings may also be able to potentially enhance returns.

To learn more about the attractive attributes of international small-caps, read Putting International Small-Caps on the Map.

 

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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. 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.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Outperformance does not imply positive results.

Active management does not ensure gains or protect against market declines.

Investments in small-cap and mid-cap companies involve a higher degree of risk and volatility than investments in larger, more established companies.