The past decade hasn’t been kind to this asset class. But, amid declining challenges, we see a compelling opportunity for investors.
International small cap equities make up a significant portion of the global market, yet many investors have minimal (or no) exposure to this asset class. However, many of the challenges international small caps have faced in recent years may now be abating, and signs suggest now could be an opportune time to invest.
Challenge | Background1 | Why it might abate |
| Macroeconomic pressures | Rising interest rates, higher inflation, and currency volatility increased borrowing costs and reduced profitability for small cap firms. Global trade disruptions also disproportionately affected these companies | A weakening U.S. dollar boosts non-U.S. assets. Global central bank interest rate cuts should improve liquidity. |
| Sector compositions | International small cap markets are more diversified into cyclical sectors such as industrials, materials, and financials, which underperform during economic downturns. Lack of exposure to high-growth sectors such as technology limits upside potential. | A pickup in economic growth (indicated by global purchasing managers’ index readings above 50)2 supports cyclical sectors. Rising commodity prices favor small cap stocks in resource-rich economies. |
| Fragmented economic recovery | The recovery from recent global disruptions, such as the Covid pandemic, has been uneven across regions. Small cap companies have struggled to regain pre-crisis growth trajectories in these conditions. This fragmented recovery has amplified regional disparities, with some markets lagging significantly behind others. | With the pandemic behind us and dislocations rebalanced, small cap companies may now be better positioned to deal with changing global trade, as they are more dependent on domestic demand and have reinforced localized supply chains. |
| Investor sentiment | Persistent underperformance and economic concerns in Europe and the U.K. led to a preference for large cap stocks and a decline in consumer confidence, impacting small cap consumer discretionary and industrial stocks. | Low price-to-earnings ratios in international small caps3 suggest potential reversion to the mean. Improved economic indicators, the potential for additional policy stimulus, richly priced U.S. assets, and a weakening U.S. dollar could boost investor interest in these undervalued assets. |
A note about risk
All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. The principal risks are generally those attributable to investing in stocks and related derivative instruments. Holdings are subject to market, issuer and other risks, and their values may fluctuate. Market risk is the risk that securities or other instruments may decline in value due to factors affecting the securities markets or particular industries. Issuer risk is the risk that the value of a security or instrument may decline for reasons specific to the issuer, such as changes in its financial condition. Smaller companies may be more susceptible to price swings than larger companies, as they typically have fewer resources and more limited products, and many are dependent on a few key managers. International investing does pose special risks, including currency fluctuation, economic and political risks not found in investments that are solely domestic. Risks of foreign investing are generally intensified for investments in emerging markets.