Searching for your next big opportunity in the equity markets?
Delving into small caps
Although small companies tend to be innovative and may grow earnings at faster rates than larger companies, the stocks of smaller companies, especially when domiciled outside the United States, are often overlooked by Wall Street analysts. In recent years, investors have shied away from small-cap equities due to large-cap equities outpacing small caps, the rise of passive investing and the risks of small-cap stocks. As noted below, financial professionals are drastically underweight international small-caps relative to international benchmark indexes. For example, the FTSE Global All Cap Index and MSCI All Country World Index (ACWI) both maintain 12.6% and 19% allocations to international small-/mid-capitalization (SMID), respectively.
The Capital Group Portfolio Consulting and Analytics team analyzed approximately 4,000 portfolios in 2019 and found that financial professionals are underallocated in international small-cap strategies.*
71%
of financial professionals have no allocation to international SMID
1.84%
Average allocation in international small-cap
*The Capital Group Portfolio Consulting and Analytics team analyzed 3,929 portfolios in consultation with financial professionals over the course of 2019. Of those portfolios, 1,154 of them had allocations to international small-cap equity strategies, meaning that approximately 71% (2,775 of 3,929) of the portfolios did not have an allocation to the strategies. The average allocation of 1.84% across all portfolios includes 2,775 portfolios with no allocation and 1,154 portfolios with an average allocation of 6.26% to international small-cap strategies.
What does this universe look like?
The opportunity set in the non-U.S. small-cap stock universe is 2.6 times larger than domestic small caps. This larger universe may increase the potential for portfolio managers to uncover investment opportunities across a wider geographic and industry landscape. Furthermore, international small-cap stocks have significantly less Wall Street analyst coverage, improving an active manager’s chance of finding value in a potentially less efficient segment of the equity markets. Yet when investors consider an allocation to small- and mid-cap equities, they tend to ignore the substantial universe of smaller cap stocks that are available overseas.
Universe of stocks per index
Source: Morningstar Direct. Domestic small-/mid-cap index is the Russell 2000 Index. International small-/mid-cap index is the MSCI ACWI ex USA SMID Cap Index. All data is as of July 31, 2020.
Average analyst coverage per company by market cap
Source: FactSet
Equity market universe includes all publicly traded companies across all the available exchanges globally. Analyst coverage is published research coverage by a financial institution on an exchange-traded company. Average analyst coverage is the average number of analysts that cover each company within a specific market cap. Market cap is as of June 30, 2020.
Global market cap flexibility may translate to upside
By adding non-U.S. small caps to an equity allocation, an investor may substantially increase the investment opportunity set and potential for adding excess returns.
Percentage of time non-U.S. SMID outpaced non-U.S. large cap
As of June 30, 2020
Source: MSCI ACWI ex USA SMID Cap Index; MSCI ACWI ex USA Large Cap Index (since June 1, 2000).
Sharpe ratios use standard deviation and excess return to determine reward per unit of risk. The higher the number, the better the portfolio’s historical risk-adjusted performance. Rolling returns are averages of an overlapping series of trailing returns going back in time; for example, periods ended every month-end going back decades. This added historical perspective may include a wider variety of market environments.
Why SMALLCAP World Fund®?
“An allocation to small- and mid-cap stocks provides exposure to some of the fastest growing and most innovative companies. For portfolios seeking capital appreciation, SMALLCAP World Fund can offer compelling growth characteristics with both market cap and geographic flexibility. You can see this in action in our solutions business. SMALLCAP World Fund, which has historically been held in our Growth and Global Growth models, was also recently added to our Moderate Growth and Growth and Income portfolios to help pursue these objectives.”
—Mario DiVito, Investment Director
Driving better results via robust research
An allocation to SMALLCAP World Fund (SCWF) may offer investors the potential to generate higher absolute and risk-adjusted returns. The large and experienced team that manages our fund uses a fundamental, bottom-up approach to drive results.
Annualized 10-year risk versus return
Source: Capital Group; Russell; MSCI; Morningstar Direct. Annualized 10-year results as of September 30, 2020. There have been periods when the fund has lagged the indexes.
Results driven by our large and experienced team
Source: Morningstar Direct; Capital Group.
A team of more than 100 portfolio managers and research analysts, as of June 30, 2020
World Small/Mid Stock (SMID) portfolios invest in a variety of international stocks with smaller market capitalizations. World-stock portfolios have few geographical limitations. It is common for these portfolios to invest the majority of their assets in developed markets, with the remainder divided among the globe’s smaller markets. These portfolios typically have 20% to 60% of assets in U.S. stocks.
What this means
Many investors may be missing an opportunity to add attractive risk-adjusted excess returns by ignoring a large segment of the global SMID sector.
Annualized risk and return of SMALLCAP World Fund versus comparable indexes
SMALLCAP World Fund has provided higher absolute and risk-adjusted returns over various time periods compared to these indexes. For portfolios seeking capital appreciation, SMALLCAP World Fund can help provide market cap and geographic flexibility. Adding SCWF into an investment mix is also reflected in the best thinking of our Portfolio Solutions Committee (PSC), who have allocated 10% of the American Funds® Growth Model Portfolio and the American Funds® Global Growth Model Portfolio to SMALLCAP World Fund.
Sources: Capital Group and MSCI.
Annualized standard deviation (based on monthly returns) is a common measure of absolute volatility that tells how returns over time have varied from the mean. A lower number signifies lower volatility. Results are as of September 30, 2020.
SMCFX (F-2)
A pioneer in global small-cap investing, this strategy seeks growth of capital by investing in some of the fastest growing and most innovative companies in the world. It invests in companies with market capitalizations of up to $6 billion at the time of purchase. As one of our most research-intensive strategies, with a team of more than 100 portfolio managers and research analysts based in both developed and developing markets, it takes full advantage of our global presence and insights.
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Portfolio Construction Concepts
PORTFOLIO CONSTRUCTION
Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. These risks may be heightened in connection with investments in developing countries. Small-company stocks entail additional risks, and they can fluctuate in price more than larger company stocks.
Class F-2 shares were first offered on August 1, 2008. Class F-2 share results prior to the date of first sale are hypothetical based on the results of the original share class of the fund without a sales charge, adjusted for typical estimated expenses. Results for certain funds with an inception date after August 1, 2008, also include hypothetical returns because those funds’ Class F-2 shares sold after the funds’ date of first offering. Please see capitalgroup.com for more information on specific expense adjustments and the actual dates of first sale.
Investment results assume all distributions are reinvested and reflect applicable fees and expenses. When applicable, investment results reflect expense reimbursements, without which results would have been lower. Please see capitalgroup.com for more information.
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FTSE source: London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2020. FTSE Russell is a trading name of certain of the LSE Group companies. “FTSE®” and Russell® are trade marks of the relevant LSE Group companies and are used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.
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MSCI World SMID Cap Index captures mid- and small-cap representation across 23 developed markets countries.
MSCI ACWI SMID Cap Index captures mid- and small-cap representation across 23 developed markets and 26 emerging markets countries.
MSCI All Country World Small Cap Index is a free float-adjusted market capitalization-weighted index that is designed to measure equity market results of smaller capitalization companies in both developed and emerging markets.
MSCI ACWI ex USA SMID Cap Index captures mid- and small-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 26 emerging markets countries.
MSCI ACWI ex USA Large Cap Index captures large-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 26 emerging markets countries.
Standard & Poor’s 500 Composite Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. This index is unmanaged, and its results include reinvested dividend and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or taxes.
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000® Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000® is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.
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