Think Small: International Small Cap Offers Big Opportunities

Market inefficiencies in international small cap have allowed active managers to add meaningful value. Historically, adding small cap to an international allocation would have boosted returns with only a minor impact on volatility.

  • December 2019

Diversifying international holdings with small cap would have boosted returns with only a minor impact on volatility¹
Impact of adding small cap to an international portfolio (15 years ended 12/31/19)

Source: FactSet. Past performance is no guarantee of future results.

Trailing returns (%) and standard deviation ("SD") for the periods ended 12/31/191,2

  1 Yr SD 3 Yr SD 5 Yr SD 10 Yr SD 15 Yr SD  
 100% Int'l Small Cap 22.42 11.74 9.65 11.61 7.04 12.36 6.92 14.82 6.92 18.16  
30% Int'l Large Cap / 70% Int'l Small Cap 22.15 11.83 9.73 11.45 6.60 12.28 6.36 14.63 6.46 17.67  
50% Int'l Large Cap / 50% Int'l Small Cap 21.96 11.91 9.77 11.39 6.30 12.27 5.98 14.55 6.14 17.40  
70% Int'l Large Cap / 30% Int'l Small Cap 21.78 12.00 9.81 11.35 5.99 12.30 5.58 14.51 5.80 17.17  
85% Int'l Large Cap / 15% Int'l Small Cap 21.65 12.08 9.84 11.34 5.75 12.35 5.28 14.51 5.53 17.03  
100% Int'l Large Cap 21.51 12.17 9.87 11.34 5.51 12.43 4.97 14.53 5.25 16.91  
Russell 2000® Index 25.52 17.08 8.59 15.71 8.23 15.90 11.83 16.93 7.92 18.50  
S&P 500® Index 31.49 12.34 15.27 11.93 11.70 11.88 13.56 12.40 9.00 13.77  

Source: FactSet. Past performance is no guarantee of future results.
1 International large cap and international small cap universes are respectively represented by the MSCI EAFE Index (MSCI EAFE) and the MSCI EAFE Small Cap Index (MSCI EAFE SC). An investor cannot invest directly in an index.
2 Standard deviation is used as a measure of an investment’s volatility. It calculates the variability of returns by comparing a mutual fund's return in each period with the average return across all periods. The standard deviation is not available for periods of less than three years.

Underinvestment in International Small Cap

  • Even though international small cap represents 5% of the global equity market capitalization, only 2% of U.S. equity mutual fund allocations are investing in funds categorized by Morningstar as international small/mid-cap
  • This significant underinvestment in international small cap may provide a long-term tailwind for asset flows into the asset class

Global investable universe
Total world equity market cap: $57.9 Trillion

Source: FactSet, MSCI, December 31, 2019.

Allocations in equity mutual funds

Source: Morningstar, December 31, 2019.
Allocations based on total assets in Morningstar categories. Charts may not total 100% due to rounding.

Attractive Fundamentals & Increasing Flows

  • Over the past five years, U.S. investors have increased their allocations to international small cap, seeking to take advantage of the asset class' risk/return profile and attractive fundamental characteristics

International small cap has attractive fundamental characteristics

Source: FactSet, MSCI, December 31, 2019.

Cumulative international small/mid-cap fund flows
(December 2014-December 2019)

Source: Strategic Insight; Foreign Small/Mid Blend, Growth, and Value Morningstar Fund Categories.

Return on assets (ROA)—An indicator of how profitable a company is relative to its total assets. Calculated by dividing a company’s annual earnings by its total assets.
Return on equity (ROE)—The amount of net income returned as a percentage of shareholder equity.
Historical earnings per share (EPS) growth—Historical growth of a company’s profit allocation to each outstanding share of common stock.
Long-term forward earnings per share (EPS) growth—Growth of forecasted, or estimated, portion of a company’s profit allocation to each outstanding share of common stock.
Price-to-earnings ratio (P/E ratio)—A ratio for valuing a company that measures its current share price relative to its per-share earnings.
Debt-to-equity ratio (D/E ratio)—A measurement of a company's financial leverage calculated by dividing a company's total liabilities by its stockholders' equity.

Active Management for International Small Cap

  • As a less efficient market than international large cap, international small cap offers greater alpha1 potential, with a universe of stocks more than twice as large but with lower analyst coverage
  • Over the last 15 years (as of 12/31/19), stocks within the MSCI EAFE SC Index that had positive earnings outperformed the MSCI EAFE SC Index by approximately 1.6% on an annualized basis
  • International small cap active managers that target companies with positive earnings may benefit from the historical outperformance of these stocks


Large international small cap universe is covered by few analysts, creating opportunity for active managers

Source: FactSet, MSCI. As of December 31, 2019. Past performance is no guarantee of future results.

Source: FactSet, MSCI. As of December 31, 2019. Past performance is no guarantee of future results.

1 Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index used as a benchmark, since the benchmark is often considered to represent the market’s movement as a whole. The excess return of a fund relative to the return of a benchmark index is the fund's alpha.

2 International Small Cap Stocks with Positive Earnings Growth are all companies within the MSCI EAFE SC each calendar year that have increased their net earnings over the prior year. This universe of International Small Cap Stocks with Positive Earnings Growth is recalculated each calendar year.

All investments are subject to risk including possible loss of principal.

Investments in international securities are subject to certain risks of overseas investing including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations.

Investments in small capitalization companies are subject to risks such as erratic earnings patterns, competitive conditions, limited earnings history and a reliance on one or a limited number of products.

Diversification does not guarantee a profit or protect against a loss in declining markets.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada.

The MSCI EAFE Small Cap Index covers all investable small cap securities with a market capitalization below that of the companies in the MSCI Standard Indices.

The Russell 2000® Index is composed of the 2000 smallest stocks in the Russell 3000® Index and is widely regarded in the industry as the premier measure of small cap stock performance.

The S&P 500® Index is capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Please visit for the most current list of countries represented by the MSCI indices.

Indices are unmanaged, are not available for investment and do not incur expenses.

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