Longer term global small companies outperform but they tend to be volatile and cyclical, says State Street Global Advisors’ Bruce Apted, head of Portfolio Management – Australia Active Quantitative Equities.

Globally, the MSCI ACWI SMID Cap Index measures 7861 small- and mid-cap stocks in 47 countries and is a fairly decent barometer of small-cap performance.

In US$ terms, this index fell 21% from January 1 to October 31, and traded on a forward price earnings (PE) of about 13 times.



How much has the recent pullback in equity markets improved the valuation outlook?

We asked Apted about what he calls The Allure of Smaller Companies, and how much has the recent pullback in equity markets improved the valuation outlook?

Apted says there’s a lot of investors interested in backing smaller companies – especially ones that might eventually become bigger companies.

“Many smaller companies are in the early stage of their corporate life cycle and can often offer potential for above market growth… they are often less appreciated by investors in their early years and they can offer potential for a valuation uplift as investors appreciate the business.

“But with the allure of outsized returns also comes greater uncertainty and risk.”

And, according to Apted, in the last 20 years the best place to be for smaller companies has been global, not local.

Smaller companies go global


Source: Factset, State Street Global Advisors from 30 January 2001 to 31 October 2022.


The ASX XEC index (by %) and with weighted moving average (the line in lighter blue)

Via tradingeconomics

Apted says the MSCI World Small Cap Index has generated 8.25% return pa and has outperformed the MSCI World Index by 2.56% pa as well as Australian smaller companies by +2.76%.

“The index has been associated with earnings growth of 6.2%, an average yield of 2.2% and an average multiple of 16.9 since Jan 2001. Good numbers.”

Smaller companies: The returns are gross



A volatile thematic, promising volatile returns

“Smaller companies are known to be more volatile than larger capitalised stocks and this can be seen in both the annualised volatility and the beta of the smaller capitalised companies.”

In comparison to the MSCI ACWI SMID Cap Index, the  MSCI World Small Cap Index captures small cap representation across 23 Developed Markets (DM) countries.

As shown below, Apted says, the MSCI World small capitalised stocks outperform the most during bull markets and underperform the most during market corrections.

“The cycles of both outperformance and under performance are usually a function of changing investor risk appetites as well as liquidity effects.”

“The excess return over the last 20 years is significant, but depending on your entry point the investor experience can be… varied,” he adds

Apted says in the graph below, look for the red shaded areas which show the exact periods of underperformance associated with equity market downturns. They’re also associated with tighter liquidity conditions (hello) and risk averse investor behaviour (hello again).

“Investor risk appetite and liquidity also impact the valuation multiples that investors are willing to ascribe to these companies,” Apted adds.

Longer-term smaller companies outperform but beware the volatility

Source: Factset, SSGA from 30 January 2001 to 31 October 2022

And the cumulative, gross returns in USD for the MSCI World Small Cap Index against its MSCI peers from October 2007 through until last month…

Via www.msci.com.

“If you look at the changes (below)  in PE (NTM) for the last 20 years and you can observe the changing valuation multiples investors are willing to ascribe during bullish and bearish market environments,” Apted says.

“The underperformance during these periods usually take the smaller companies from above market valuations to more attractive longer term valuations and this graph below places current valuations in historical context.”

Relative Valuations Global Small Companies – MSCI World Small Cap Index

Via SSGA Source: Factset, from 30 January 2001 to 31 October 2022


MSCI World Small Cap Index: Weighted by sector and geography:

Via State Street, source: MSCI


In an absolute sense – smaller is bigger – relatively speaking

“After the recent correction in the global equities, smaller capitalised stocks are now trading at lower valuations relative to history in an absolute sense and relative to the MSCI World Index,” Apted says.

“When liquidity conditions improve and investors become less risk averse the cyclical environment should be more favourable for smaller companies.”