Some money managers are touting international small-cap accounts to their institutional clients -- and showing results to back up their claims.
International small-cap managers, the majority of which are active, showed spectacular portfolio performance as 1999 closed, posting returns from Unibank Investment's 55% to Pinnacle International's 127.5%.
The keys included investing in technology and media and advertising companies, managers said, as well as catching the wave of small companies taking off on Japan's Jasdaq exchange.
Traditionally, international small-cap markets are home to less glitzy, value-style stocks of companies in basic industries such as construction and textiles. But small-cap markets around the globe are often the first homes of tech stocks, many of which took off last year.
Active managers that emphasize stock picking benefited last year. While small-cap indexes continued to underperform their large-cap equivalents in 1999, the performance gap narrowed significantly. The Morgan Stanley Capital International Small Cap Europe Australasia Far East index was up about 17.7% in 1999 vs. almost 25.3% for the MSCI EAFE index over the same period. In 1998, the EAFE small-cap index was up 5.4% vs. 18.2% for EAFE.
On top of the strong returns, international small-cap stocks diversify a portfolio better than do emerging markets, which are more volatile, according to a new report by Unibank Investment Management. Emerging markets stocks also are more closely correlated with the Standard & Poor's 500 stock index, according to the report. In contrast, overseas small-cap companies are more dependent on the health of their local economies than on the U.S. economy, according to the report.
Investors can get more diversification by investing in international small-cap stocks, as well as a better risk/return ratio, said Henrik Bak, president of Unibank Investment Management in New York.
"It's better to go to developed markets and go deeper" into those markets than to invest in emerging markets, he said. "Emerging markets are also more closely related to the dollar."
Unibank runs two small-cap funds, one European and the other international, which total $385 million. That money is split evenly between retail and institutional investors, said Mr. Bak. The European small-cap fund was up close to 55% through the end of December, and the International Small Cap fund was up 56.5%.
One consultant, however, was more leery about the arguments for investing in overseas small-cap markets. "There is a lack of evidence to conclusively prove or disprove either the existence of a return premium or an unusual diversification benefit from investing in international small-cap compared to international large-cap stocks," according to a recent report by Frank Russell Co., Tacoma, Wash.
The problem with international small caps is that there's no universal definition of the market, which makes compiling statistical evidence extremely difficult, according to the Russell report.
For example, a company in the MSCI small-cap EAFE index has a market cap of $300 million to $700 million. Money managers running international small-cap portfolios often invest in companies with market caps three or four times that amount.
Regardless, managers were happy with year-end results. Pinnacle International Management LLC's international small-cap composite portfolio, according to preliminary results, was up 127.5% for the year. "It's the first year of solid outperformance" for overseas small cap stocks, said Andrew Reitenbach, portfolio manager with Pinnacle in New York.
Putnam Investments Inc.'s international small-cap portfolio also saw high-reaching gains. It was up 83.6% for the year through Dec. 22.
Such returns are gaining the attention of institutional clients such as pension funds, said Josh Byrne, portfolio manager with Putnam in Boston. But they are more likely to invest in an overseas small-cap portfolio as a way of generating returns, not as an allocation to a separate asset class.
Pension funds are "more and more looking for alpha-generating products," he said. Institutional investors are looking at overseas small-cap portfolios, along with emerging markets and venture capital funds as a way to add a "little sizzle," he said.