Investors first embraced American small cap stocks in the late 1970s, when small companies became recognized for their potential to grow rapidly as a result of being more nimble and able to adapt to change more quickly than larger competitors. Since their first great boom, U.S. small caps have proven to be one of the most successful asset classes, especially for talented active managers.
While U.S. small cap, international large cap, and even emerging markets have all attracted significant assets over the years, small cap stocks in developed non-U.S. markets remain largely uncharted territory. We believe there are a number of reasons that investors should consider an allocation to international small cap stocks:
• The breadth of the international small cap equity universe provides significant opportunities
• Inefficiency of international small cap market offers alpha potential for active managers
• International small cap offers diversification to mainstream equity classes
• International small cap investors are less impacted by currency fluctuations than other international Investors
Reason 1: The Breadth and Depth of the International Small Cap Market Provides Opportunity
From a size standpoint, we believe the non-U.S. small cap equity market is large enough to warrant interest by U.S. investors. As the table in Exhibit A below illustrates, small/mid cap investment opportunities globally represent 66% of the investable universe, compared to 8.6% for large caps. And while international small and mid-sized companies constitute 41% of that investable universe, these companies provide more than 91% of the equity investment opportunities in developed international markets (i.e. 3,567 = 91% of (3,567 +346))