S&P Indices has published research demonstrating the sustained outperformance of small-cap stocks versus their larger peers in emerging market equities.
The S&P Emerging SmallCap Index has posted a 16.6 per cent ten-year compound annual growth rate as of 30 September 2010, compared to a 13.2 per cent CAGR for the S&P Emerging LargeMidCap.
In fact, the SmallCap Index has beaten the LargeMidCap Index in eight out of the ten years between 2001 and 2010.
The performance differential has been particularly large over the past year, with the SmallCap Index returning 17.2 per cent for the year to the end of September 2010 compared with 10.9 per cent for the LargeMidCap Index.
Alka Banerjee, vice president of global equities at S&P Indices, says: “Today, emerging markets are viewed as the growth engine for the world and are entrenched as standard allocations in investors’ global equity portfolios. As capital flows to these areas have increased in recent years, small-cap stocks have outperformed their larger peers. Despite this trend, however, many investors do not have dedicated small-cap exposure within their emerging market portfolios.
“The significant performance differentiation highlighted by our analysis between small-caps and large- and mid-caps within the emerging markets, and the possibility of greater diversification, provide a compelling argument for investors to carve out dedicated allocations for emerging market small-caps.”
This phenomenon of emerging market small-cap outperformance generally holds across regional, sector and style indices and so does not seem to be driven by any of these underlying fundamentals. It is in contrast to the earlier days of emerging markets investing when small-caps did not post such a dominant performance over their larger-cap peers and when investor focus was on larger companies.
Importantly for investors, although correlations have increased in recent years, emerging market equities continue to provide a valuable source of diversification for investors. Here, too, small-cap equities exhibit superior qualities to mid- and large-caps. Over time, small-cap emerging market equities have exhibited lower correlations to the developed markets relative to their large- and mid-cap peers.
Up until recently, small-caps experienced lower volatility than large-caps in emerging markets, but the last few years have seen a reversal in this trend. As the level of trading in small-cap equities increases, emerging market volatility overall remains above that of developed markets.