Global small-caps: Small investment, big returns

For the three years to January 19 2012, the MSCI All-Country World Small Cap index and the FTSE Small Cap (excluding Investment Trusts) index produced impressive returns of 75.96 per cent and 62.48 per cent respectively.

This easily outstripped the 56.05 per cent return from the FTSE 100 and the 47.82 per cent figure from the MSCI All-Country World index over the same period, according to FE Analytics.

However, the way in which fortunes can be reversed is demonstrated by the fact in 2011, a year of extreme volatility, the two small-cap indices underperformed their larger-cap counterparts. The FTSE Small Cap (excluding Investment Trusts) index posted the worst loss of 13.27 per cent over the year to January 19 2012, compared with the FTSE 100, which posted a loss of 0.51 per cent.

Over the year to date, however, the tide has turned slightly. The Russell Global ex-US Small Cap index has returned 5.8 per cent compared with 5.1 per cent for the Russell Global ex-US Large Cap index.

The nimbleness of smaller companies and their ability to take advantage of opportunities not available to their larger peers means that, since the start of the 2000s, small caps have beaten large caps in all but four countries, according to the 2012 annual report of the RBS Hoare Govett Smaller Companies indices.

Of the major national markets, only smaller companies in Malaysia, Mexico, Norway and Taiwan produced negative long-term premiums, even though 2011 was a “year of disappointment for small-cap investors, and every market except South Africa had a negative return from small caps,” according to the report. Overall, global small caps produced an average premium of 5 per cent a year.

The report also notes performance in the Hoare Govett Smaller Companies (HGSC) indices of UK stocks is actually driven more by specific industries and effects produced by the size of particular stocks than by any orientation towards the UK.

“The HGSC has performed well because many of the worst-performing stocks, such as the banks, were too large to enter the index,” the report argues.

Neil Robson, global equities fund manager at Threadneedle, says that in difficult economic periods, investors tend to flock to perceived safe havens such as defensive large caps while shunning smaller companies that are regarded as being vulnerable for reasons such as a lack of cash reserves, lack of brand awareness and potential difficulties in reducing costs.

But he argues: “There are good reasons for believing that over the long term, smaller companies hold greater investment potential than large caps, given their latent ability to grow earnings at a faster pace than well established businesses.

“This partly reflects the fact that smaller companies are starting from a much lower base but also because they may have exploited untapped niche sectors or have developed new technologies or products.”