Research released by VanEck on Friday has shown that global small caps, which are typically underrepresented in Australian investment portfolios, have outperformed international large- and mid-caps and Australian small caps over the long term.
VanEck suggested that given local managers are following the MSCI World ex Australia Index as their benchmark, which focuses on large- and mid-cap companies, they are overlooking the remaining 15 per cent of the market comprised of global small-caps and limiting potential investment opportunities for investors.
Commenting on the findings, Arian Neiron, VanEck’s chief executive officer and managing director, emphasised the missed opportunities.
“Unlike Australian small companies, global small caps have historically demonstrated outperformance relative to large companies over the long term,” Mr Neiron said.
He explained that, for example, many small unprofitable mining companies listed on the Australian Stock Exchange are in the “infant” stage of the business cycle, raising capital for exploration or mine development, which is a phenomenon less prevalent in offshore exchanges due to stricter rules on profitability and financial viability for listing.
“Weaker listing requirements at home mean Australian small caps have almost double the exposure to non-profitable companies, compared to global,” said Mr Neiron.
Moreover, he noted that many global small-caps, in the context of market size, would be characterised as mid-caps in Australia when measured by market capitalisation.
“The higher average market capitalisation of global small-caps relative to Australian small-caps implies that these companies are more established businesses in the ‘growth’ phase of the business cycle. This means that sales and earnings growth are likely to be more of a feature of global small companies.
“We believe allocating to global small caps should be an integral part of investors’ satellite portfolio strategy, the way they invest in Australian small companies. Like here though, investors need to be selective because the global small-cap universe is littered with haves and have-nots.”
VanEck’s research paper highlights that an approach with a historical track record of outperforming in the large and mid-cap universe, while providing defensive characteristics, is quality, which can also be applied to identify small-cap companies with strong financial positions and the ability to maintain earnings.
Presenting an alternative perspective, in April, Maple-Brown Abbott looked at how Australian small cap companies are positioned if there is to be another banking crisis by examining lessons from the Global Financial Crisis in 2008.
What the firm found was that while the Australian small cap market had experienced the worst period of underperformance since the GFC with significant valuation compression experienced by smaller growth companies, recent changes, including a greater skew to consumer-exposed companies, signalled a turnaround.
Moreover, the firm acknowledged that looking forward, Australian small-cap companies could be added to investment portfolios as a means of diversification, potentially offering attractive opportunities for investors seeking exposure to this asset class.