Bottom-up stock selection more important than ever
In a recent podcast, Aidan Farrell, Director of Global Small Cap Equities at Eaton Vance discusses investment opportunities presented by the global small-cap sector for Australian investors.
The MSCI World Small Cap Index captures small cap representation across 23 Developed Markets countries. With 4,203 constituents, the index covers approximately 14% of the free float-adjusted market capitalization in each country and presents a very broad opportunity set.
Australian investors should consider opportunities in this space for one very simple reason – diversification.
The MSCI World Small Cap Index holds 169 Australian small-cap companies categorised by MSCI versus over 4,000 in the global small cap benchmark itself. Apart from this, we believe the investable universe is up to about 7,000 companies. So, diversification away from home country is the biggest draw from an Australian perspective.
Australian small caps over the last 20 years have performed strongly. But the global small-caps have performed a little bit better, not on an absolute returns basis, but on risk adjusted returns, taking into account volatility within that period of time as well.
Also, the performance of small caps versus large caps has been very strong over the last 20 years. As an example, global small-caps have achieved a total return of about 270% in Australian dollar terms over the last 20 years. And that’s over double that of global large caps, with better risk adjusted returns also.
It comes as no surprise that the lion’s share of equity market capitalisation and investors’ attention are focussed on large cap companies, which is about 1,600 companies globally in the large cap benchmark analysed on average by about 15 research analysts from the broking community, the sell-side community. Compare that to the over 4,000 companies in the small-cap index, which on average are only looked at by about five sell-side analysts.
We estimate that 17% of the benchmark doesn’t have any analytical coverage whatsoever on the sell side. From our perspective, we would rather be investing in parts of the equity market which are relatively under-appreciated and the small cap market is certainly fertile territory from that perspective.
Bottom up stock selection is our core strength in small-cap investing.
Please click on the link below to hear the detailed discussion: