Hidden gems and a focus on domestic economies have produced robust inflows and solid returns. Narrowing the risk gap.
October 2, 2015
By Robert Stowe England
As global equity benchmarks have skidded this year, many international small-cap funds that invest outside the U.S. have either held their own or shown positive returns. “Overall, international small-cap funds are doing better than the large-cap funds, no matter if they invest in growth or value. Clearly there’s some advantage to the smaller ones this year,” says Gregg Wolper, senior mutual fund analyst at Morningstar.
The relatively better performance of international small caps belies the notion that they are riskier than U.S. small caps, according to Roger Edgley, lead portfolio manager at the Wasatch International Small Cap Growth Portfolio, an international small-company growth fund. Edgley finds the perception of greater risk on the international level to be outdated. Small companies in emerging markets have “narrowed the gap” with U.S. small caps, while “the really good companies in Europe and Japan are now world-class.”
The ability of international small caps to defy a broader slide by international large caps is reflected in the equity indexes. The MSCI All Country World index, an all-cap benchmark that excludes U.S. equities, has declined 5.71 percent year-to-date as of September 21. By contrast, Morningstar’s Foreign Small/Mid Growth index has gained 4.29 percent year-to-date, while the return on the MSCI index for small companies outside the U.S. is close to even at –0.09 percent for the year.
Demand for international small caps has been boosted in part by net inflows from institutional investors. During the second quarter of 2015, investors shifted $970.9 million in assets into this fund category, according to eVestment, a Marietta, Georgia–based investment data firm. This marked the seventh consecutive quarter of net inflows. Over those seven quarters, investors boosted by $5 billion their net allocations to international small caps outside the U.S. Most of that gain in net inflows, $3.87 billion, occurred over the past four quarters.
Because there is a lack of research and only sporadic media interest in most international small companies, shoe leather investigative efforts can lead fund managers to hidden gems the markets have not yet discovered, which can provide solid returns over time. “It’s a huge opportunity set — almost every small-cap company outside the U.S.,” says Edgley. The $2.4 billion Wasatch International Small Cap Growth Portfolio typically holds stock in 80 to 90 firms, whereas the $455.9 million Wasatch International Micro Cap Portfolio has 150 to 160 names.
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