The current global economic environment reflecting an expectation of interest rate cuts presents an opportune moment for investing in small caps.
A fund manager specialising in exchange-traded funds (ETF) has suggested the global economic conditions existing currently are creating the perfect opportunity for Australian investors to consider having an allocation to small caps in their portfolios.
“[The reason why the time is right to invest in small caps] is mostly to do with the historical sensitivity to interest rates,” Global X senior investment strategist Billy Leung said during a webinar last week.
“[So historically] we do see that small caps have outperformed large caps following a rate-cutting cycle and if you look at the reasons why this is so, it’s because generally small-cap companies tend to rely more on financing for growth and it makes them more responsive or more sensitive to lower borrowing costs.
“So globally we do have rate-cutting expectations, in the US as well, and it does suggest historically that small caps could be positioned for a meaningful recovery.”
Leung pointed out the inclusion of small-cap company shares in a portfolio also adds a layer of diversification, especially for domestic investors due to the sector concentrations inherent in the Australian stock market.
“Australia’s equity market is one of the most concentrated in the world. The ASX 200 is heavily skewed toward large-cap financials [and] it obviously includes a lot of resources companies. [In fact], banks and [mining companies] actually make up nearly half of the Australian equity index,” he said.
“That actually leaves many Australian portfolios lacking exposure to broader segments that we have seen [for example] in the US economy.”
Global X provides Australian investors with an avenue to US small caps through its Russell 2000 ETF.
“[Via this ETF], investors can gain access to a segment of the market that benefits from US growth, also progress policies, monetary easing and it also helps enhance portfolio diversification,” Leung said.
He took the opportunity to dispel traditional concerns over the fundamental characteristics of US small-cap companies.
“One of the biggest misconceptions about small caps is they are highly leveraged, they are financially weak or vulnerable, but this perception is outdated,” he said.
“[For instance], the Russell 2000 companies’ net debt-to-equity level has slowly been declining and improving in a way where it is actually converging with the level of the S&P 500 [companies].
“So in terms of [small caps possessing] financial vulnerability or financial weakness, I don’t think that’s a correct statement and I think this perception is a bit misleading.”
''