3 Reasons To Invest In International Small-Cap Equities

by: Manning & Napier

Small, well-run companies exist all over the world providing investors with dynamic growth potential and attractive investment opportunities. Despite this, international small-cap equities remain underinvested and largely overlooked by investors. While it might be hard to believe in today's world of increased globalization, advanced technology, and greater access to capital markets that international small-cap stocks remain mostly undiscovered, investors should view this as an opportunity. We believe there are unique benefits for investors to weigh when considering an allocation to international small-cap equities.

  1. Historical Outperformance
    International small-cap equities have outperformed the broader U.S. equity markets over the past 15 years on both an absolute and risk-adjusted basis, while at the same time consistently outperforming international large-cap equities on a trailing 3-year, 5-year, 10-year, 15-year, and 20-year basis. Research shows many international small-cap companies receive limited analyst coverage, resulting in a vast and largely overlooked universe of opportunity. This dynamic allows for price inefficiencies, which can translate to higher return potential and reward disciplined and experienced managers who take the time to research international small-cap equity investment opportunities.
  2. Growth Opportunities at Attractive Valuations
    In today's growth-constrained world, international small-cap companies are expected to grow earnings faster than U.S. and larger international peers over the next 12 months. Even with these favorable growth characteristics, international small-cap equity valuations trade at a discount to domestic small and large-cap companies and only at a modest premium to international large-cap companies despite a 50% higher expected growth rate.
  3. Portfolio Diversification
    In addition to providing investors with higher return potential and excellent growth opportunities, international small-cap equities can also act as an effective diversifier in portfolios. International small-cap equities have historically exhibited a lower correlation to the S&P 500 than domestic small-cap and international large-cap stocks. Adding dedicated international small-cap exposure to a portfolio has the potential to increase expected return, while at the same time helping to reduce overall portfolio volatility.

Despite the potential for continued outperformance, higher expected growth, and enhanced portfolio diversification that international small-caps may provide, many investors are not yet taking advantage of the opportunities that exist throughout the world. We think it's time investors consider a dedicated allocation to international small-cap equities.