Just as investors needed to diversify their equity portfolio overseas, they're now beginning to shed their home bias when it comes to small-cap equity strategies.
However for money managers, investing in smaller companies overseas comes with high hurdles in cost, liquidity and capacity constraints.
As clients worldwide globalize their equity portfolios, they're “typically not investing as much in small caps,” said Debbie Clarke, head of the global equities boutique at Mercer, London.
Even as investors diversify into emerging markets, they're usually investing in larger global companies within that sector.
To balance the tilt toward large-cap stocks, some investors have increased their exposure or are considering a separate allocation to global or international small-cap mandates, which often combine emerging and developed markets, said Nick Hamilton, head of global equity products at Invesco Perpetual, Henley-on-Thames, England. Global emerging markets small-cap strategies are also gaining traction, sources said.
Inflows are relatively modest, coming mostly from institutions in Europe, Australia and Canada, but some U.S. pension funds including the $1.8 billion Fort Worth (Texas) Employees' Retirement Fund are also making the move.
“The home-country bias has gone down radically for large-cap equities,” said Mark Thurston, head of global equity manager research at Russell Investments, Seattle. “While the trend for globalizing small-cap exposure is real and it is happening, it's still pretty small compared to all the dollars that's out there.”
Managers competing for inflows into global small-cap strategies include Dimensional Fund Advisors, Invesco Perpetual, Franklin Templeton Investments, Pyramis Global Advisors, Aberdeen Asset Management PLC, Schroders PLC, Hermes Fund Managers Ltd. and Ashmore Group PLC.
“We're seeing global small-cap (equities) increasingly being pulled out as separate searches,” said Michael J. O'Brien, London-based managing director and global head of J.P. Morgan Asset Management's institutional client group.
“Running a small-cap portfolio on a global basis offers a broader opportunity set and some diversification benefits” compared to a global equity portfolio tilted toward large-cap stocks, said Andrew Kirton, London-based global chief investment officer at Mercer. “We would start from the premise that (investors) should have a long-term bias to small caps, depending on valuations.”
In addition, combining developed and emerging markets small-cap equities can be a more efficient way to implement the portfolio, said Stephen Clark, vice president and North American head of institutional at Dimensional Fund Advisors, based in Austin, Texas. Dimensional has $250 billion in total assets under management, including $50 billion in dedicated small-cap strategies. The firm takes a systematic approach to small-cap investing, which allows the firm to take advantage of liquidity constraints within the sector rather than be hampered by it, Mr. Clark added.
The MSCI World Small Cap index has outperformed the MSCI World index over the past three, five and 10 years on an annualized basis. In the 10 years ended Sept. 30, the MSCI World Small Cap returned 11.97% compared to 8.61% for the MSCI World during the same period, according to data from MSCI.
The correlation between the S&P 500 and the MSCI World ex-USA index is about 0.9 compared to 0.82 between the S&P 500 and the MSCI World ex-U.S. Small Cap index.