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.