Global small-cap companies need consideration

small caps allocation

Limiting small-cap portfolio allocations to companies listed on the ASX will restrict the returns investors can enjoy from this sector.

Investors should look beyond Australian companies when including an allocation to small caps in their portfolios to take advantage of the strong returns this sector generates globally, research from an exchange-traded fund manager has concluded.

“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,” Van Eck Asia-Pacific managing director Arian Neiron observed.

“We think Australian investors are overlooking an opportunity by only investing in small companies closer to home.”

One of the limitations in employing a home-country bias when investing in small caps stems from the characteristics of Australian companies making up this segment, Neiron pointed out.

“Many small unprofitable mining companies listed on the Australian Securities Exchange (ASX) 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,” he noted.

Further, he warned investors to be wary of market size definitions applied on the ASX when assessing small-cap companies located overseas.

“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,” he noted.

“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.”


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