Advisors who want to give their clients an advantage in current market conditions should be looking to small cap companies, according to MSCI, a support and research firm and provider of indexes for the financial industry with headquarters in New York City.
Small caps in both developed and emerging markets have out-performed large caps and historically that favorable status has held true after most recessions and economic slowdowns similar to the one the world is now coming out of, according to MSCI research released recently.
The longer the investor is willing to hold the stocks of small cap companies, the better returns they will see, the firm said. Since December 1998, the MSCI Emerging Markets Small Cap Index outperformed the MSCI Emerging Markets Index by an annualized 0.54%, the firm said. MSCI defines small cap as the bottom 30% of companies by size and large cap as the largest 30% of companies by size.
In addition, since 1998, the MSCI World Small Cap Index posted an annualized excess return of 2.69% compared to the MSCI World Index.
That trend was reversed for a while. “Between 2011 and 2020, however, as global equity markets rallied on the back of central banks’ accommodative monetary policies, small caps struggled to keep pace with large caps,” MSCI said. The MSCI World Small Cap Index underperformed the MSCI World Index by 0.40% on an annualized basis, while the performance of the MSCI Emerging Markets Small Cap Index fell short of the MSCI Emerging Markets Index’s performance by an annualized 1.4%.
The trend has returned with the market slowdown of recent years and the re-emergence into more favourable territory. This circumstance is causing investors to evaluate new opportunities, the firm said, even though more risk is associated with small caps. Small caps are currently exhibiting strong earnings potential and cheaper valuations.
In addition, MSCI said it found the frequency of outperformance of smaller companies in both developed and emerging markets steadily improved the longer the investor held the investments. Over a 15-year investment horizon, small caps have outperformed large caps about nine in 10 times
Playing into the strong performance projected for small caps following an economic slowdown, the International Monetary Fund has forecast a slowing global economy for later this year followed by a rebound next year, MSCI noted.
Investors, particularly institutional investors, frequently have balked at investing in small-cap companies because of their lower liquidity. However, MSCI said it has found that over the last 10 years, small caps’ liquidity has improved, increasing their attractiveness to institutional and retail investors.