Why Asset Allocators Should Consider International Small-Cap
article , video 09-21-2017

Why Asset Allocators Should Consider International Small-Cap

Portfolio Manager David Nadel describes why international small-cap is an asset class worth considering.  

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Asset allocators should be looking at the international small-cap asset class as maybe a two to five percent permanent allocation within a total portfolio for essentially one reason. In a sound bite, superior risk adjusted returns with very low correlation.

What aspects of the asset class might surprise investors?

I think people are often surprised by the quality of the businesses. I think that this asset class really offers a quality premium, in the sense that if you think about being a $3- or $4 billion company from a market like Australia or Finland or even the UK; you’ve had to figure out how the whole world works. You operate across borders. You have multiple places where you’re producing product, you have a diversified customer base.

These are very, very sophisticated businesses. If you think of the comparable market cap in the US, you could sell just to the state of California and achieve a $3- to $4 billion market cap. So, the standard for these companies is extremely high.

There tends to be a very strong sense of permanence for these businesses; very long average CEO tenure, often a family ownership of the business, or at least a family involvement; they think very long term. They return a lot of money to shareholders in the form of dividends.

And so, I think the quality profile is extremely high within this asset class, and that does often surprise people.

I do think people would be surprised by how big the asset class is, because I think, primarily, asset allocators have tended to go to international large-cap when they think non-US.

But I think they would be surprised to know that there are about three times as many companies in the international small-cap asset class as there are in the comparable sized market cap in the US. And there’s about twice as much aggregate market cap. So, there’s a lot to choose from.

Describe the risk profile of the asset class.

The risk profile of international small-cap is also counterintuitive. I think the impression that people tend to have from watching the news or reading the news is that the international markets are extremely volatile, because there's always some sort of problem going on somewhere in the world.

The reality is, statistically, this is an asset class that has a superior standard deviation to domestic small-cap. It's comparable to international large-cap. On a risk-adjusted basis, it’s superior to both.

And then, when you combine that with low correlation, you're, in terms of building an overall portfolio, you can understand why people come to that kind of two to five percent overall allocation.

What sort of environments does international small-cap tend to do best in?

I think international small-cap tends to do particularly well in rising rates, rising interest rate environments. That's what we found with our studies. It actually outperforms in both declining rate environments and rising interest rate environments but that outperformance over international large-cap is greater in a rising rate environment than in a declining rate environment.

I think its relevant now because with things like the German bund at 25 basis points. More likely, we're headed towards rising rates than further declining rates.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the person speaking as of July 12, 2017 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

The Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

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