In ten of the last 13 years, small listed companies (small caps) performed better than companies with large market capitalisations (large caps), according to a study by Allianz Global Investors.
The study – “Is small beautiful?” – reveals that while the MSCI World Large Cap Total Return Index rose by approximately 80 per cent between January 2001 and September 2013, the corresponding small-cap index almost tripled over the same period. Only in the years 2007-08 and 2011 did large companies fare better than small ones.
Stefan Scheurer, senior capital markets analyst at AllianzGI and author of the study, points to two factors for the outperformance and underperformance of small caps: “On the one hand, many small caps are still in a growth stage. This results in a greater increase in profits and share prices. Investors are thus rewarded for the greater risk inherent in small caps. On the other hand, however, during crises and periods of heightened risk aversion, as investors flee, small caps underperform large caps. One reason for this is the lower liquidity of small caps because of their lower market capitalizations. That is what we saw when Lehman collapsed and during the euro-zone government debt crisis.”
A regional breakdown of the performance of small- and large-cap companies is also interesting: first, both in Europe and in North America the annual performance of small caps since 2001 has been six per cent higher than that of large caps on average. In absolute terms, there was an average yield of eight to nine per cent per year for small caps compared to an average of two to three per cent per year for large companies. Second, small caps have also proven to be profitable in Japan. While Japanese large caps over the last 13 years on average were negative by 0.5 per cent per year – the Lost Decade – small caps generated an average return of 3.5 per cent per annum.
“For a country that had real economic growth of less than one per cent per year and inflation and interest rates close to 0 per cent over the same period, those rates are significant,” says Scheurer.
For Andrew Neville, small-cap fund manager at AllianzGI, this confirms the concept of Allianz Global Small Cap Equity fund. This fund was launched in June 2013 and is based on a strategy which has been successful for several years. The composition of regional sub-portfolios is based on the expertise of the local small-cap teams of AllianzGI. The overall portfolio consists of 155 to 190 stocks, about half of which are US companies and around a quarter European small caps. About half of the remaining quarter of the portfolio are issues from the Asia-Pacific region and even Japan.
“As experience and research are the be-all and end-all for successful stock selection in the small-cap sector, regional expertise is key to success. Allianz Global Investors has decades of experience here and each of the small-cap teams in Europe, Japan and Asia-Pacific has been successfully managing small-cap products for around 15 years, and the US team for 30 years,” says Neville.
In the UK, small caps outperformed large caps by 166.5 per cent from 2001 to September 2013.
“Small cap examples out of the UK which contributed positively to the performance of the Allianz Europe Small Cap Equity fund in recent years are – among others – Restaurant Group, a casual dining restaurants and pubs operator, and Rightmove, UK’s leading property online portal,” says Neville.
Nick Smith, head of European retail sales (ex-Germany) at AllianzGI, says: “As the research shows, small caps often have an advantage over large caps as they are able to finance their own growth, which means they are not as constrained by the effects of banks restricting their lending. They can provide diversification benefits, as they are more risky and more volatile but offer potentially higher returns; so can form an important part of an investment portfolio.”