Ausbil Investment Management’s global small cap portfolio manager, Tobias Bucks, told SMSF Adviser that allocations to the sector had been growing across all investor types in Australia in recent years following increasing recognition that global small caps offered less risk than domestic equities for a similar return pay-off.
“Five years ago in Australia, there was a limited allocation to global small caps, and that’s now increasing across different types of investors including IFAs, institutions and SMSFs,” Mr Bucks said.
“You are seeing an increasing allocation and we would expect that to continue to increase because it’s got a better risk-adjusted return profile. Global small caps use a similar return profile to domestic equities but for much less risk.”
Mr Bucks pointed to figures showing the Sharpe ratio for the MSCI World Small Cap Index compared to the MSCI Australia Large Cap Index, which revealed that over the last 20 years, both indexes had returned 9 per cent annually, but the small-cap index had done so for 17 per cent risk compared to 21 per cent for large-cap Australian equities.
“One reason global small caps have a better risk-adjusted return is that there is a lot less top-down risk — when you look at large and mid-cap stocks, whether they are the big banks or global tech stocks like Alphabet, the returns of those stocks are much more affected by the economic environment and what interest rates are doing,” he said.
“Looking at global small caps, it’s driven a lot more by what the board and management are doing with the business. What you are trying to find is emerging global titans, businesses that are the best in the world at what they do but are still quite small geographically.”
However, Mr Bucks said the use of an active manager was important to get optimum returns in this space, given that index-based strategies often underperformed.
“ETFs and index products are great in themselves, but in global small caps, they will always underperform because of the numbers of stocks and the difficulties in trading,” he said.
“When stocks come into the small-caps index from mid-caps, they tend to take up a high weighting, but usually something has gone wrong with their business model which is the reason why their market cap has gone down so much. It makes it much harder for passive managers to deliver in this asset class.”
