In a recent article – Global Emerging Markets Small Caps: Benefits to going off the beaten path – BNP Paribas said the emerging markets small-caps space provides both geographic diversification and greater exposure to country specific macro trends.
BNP Paribas senior portfolio manager of global emerging market equities, Rick Wetmore, said emerging markets (EM) small-caps enjoy the benefit of local orientation and greater independence from government intervention.
Mr Wetmore said EM small-caps are growing at a faster pace than developed markets. He also pointed out that they tend to be more entrepreneurial.
“EM small-caps offer investors greater opportunity for outsized returns due to a broader, more inefficient universe, attractive risk reward characteristics and diversification through more exposure to domestically orientated companies,” he said.
According to Mr Wetmore, when entering the EM space, investors should look for quality companies with resilient business models.
Consumer staples are currently an attractive sector due to their exposure to local markets, he said.
“Emerging market consumer companies with strong brands have experienced generous levels of growth in demand over the last 15 years."
"This has come as consumer incomes have risen, creating an expanding middle class.
“The better performance of smaller-cap stocks represents the improved opportunity set for more nimble and market-driven companies, along with the reduced presence of SOEs in this segment of the market.”
While there are opportunities within the space, there are risks to small-cap stocks.
“One of the most significant risks to EM small-cap stocks over the next 12 months is the potential reallocation of capital to the US as the US Federal Reserve begins to raise rates,” Mr Wetmore said.
In order to manage this risk, the rules of portfolio diversification need to be followed.
However, although there will be volatility surrounding the timing and magnitude of the interest rate hike in the US, this trend will also present opportunities.
“Periods of uncertainty and volatility present some of the greatest opportunities in emerging markets allowing us to add value over the long-term by investing in well-run, quality-growth companies at attractive valuations,” said Mr Wetmore.
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