A home bias may be hurting investors

A new research paper Global small-caps: An overlooked opportunity, released today, from VanEck shows global small-caps, which are typically underrepresented in Australian investment portfolios, have outperformed international large- and mid-caps as well as Australian small-caps over the long term.

Arian Neiron, CEO and Managing Director, VanEck, Asia-Pacific said, “Australian investors have traditionally been attracted to Australian small caps, yet locally, the asset class has consistently underperformed its large- and mid-cap counterparts, hamstrung by structural nuances. Unlike Australian small companies, global small caps have historically demonstrated outperformance relative to large companies over the long term.

“We think Australian investors are overlooking an opportunity by only investing in small companies closer to home. For example, many small unprofitable mining companies listed on the Australian Stock Exchange are in the ‘infant’ stage of the business cycle to raise capital for exploration or mine development. This is less common globally, as offshore exchanges have stricter rules around profitability and financial viability requirements for listing. Weaker listing requirements at home mean Australian small-caps have almost double the exposure to non-profitable companies, compared to global.

“Local investors might also be surprised to learn that 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.”

One approach, the new paper highlights, that has shown historical outperformance in the large and mid-cap universe while offering defensive characteristics is quality. This approach can also be used to identify small-cap companies which have a strong financial position and the ability to maintain earnings.

The paper shows the outperformance of quality international small companies is higher than the outperformance of quality large international companies. The findings are supportive of Economist Robert Novy-Marx’s assertion that quality small companies are able to generate higher relative returns than quality larger companies.