EM small caps: Hidden gems in plain sight?

Our team makes the case for strategically investing in EM small caps and  for employing an actively managed approach to this underutilized asset class.

Views expressed are those of the author and are subject to change. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional or institutional investors only. Please refer to the risk section in the PDF available for download below.

Four reasons we believe in a strategic allocation to EM small caps

  1. Strong performance potential
  2. Portfolio diversification benefits
  3. Direct exposure to domestic EM growth opportunities
  4. An undercovered, inefficient market = fertile ground for active managers

Emerging markets (EM) have come a long way over the past three decades. As these markets have evolved and matured through the years, the number of EM equity strategies has proliferated in response to growing investor acceptance of and interest in the asset class. Today, many investors — retail and institutional alike — have a dedicated allocation to EM equities, yet most continue to be firmly biased toward the larger end of the market-capitalization spectrum.

In our view, this results in an unfortunate missed opportunity because a well-built portfolio of EM small-cap stocks can be an effective complement to an existing core EM equity allocation. In this paper, we make the case for strategically investing in EM small caps and for employing an actively managed approach to this underutilized asset class.

A primer on EM small caps

Definition: EM small-cap equities are generally defined as stocks of companies domiciled in non-developed countries, with market capitalization ranging from US$500 million to US$5 billion.

The opportunity set: The EM small-cap universe is large and diverse (~3,100 companies)1, offering investors a wealth of potentially compelling opportunities (both within and outside the standard index).

The MSCI EM Small Cap Index at a glance1

  • Launched: 1 June 2007
  • Total market capitalization: US$726,490 million
  • Number of countries: 26
  • Number of companies: 1,653

The case for EM small cap

1. STRONG PERFORMANCE POTENTIAL

EM small-cap equities as a group have historically delivered attractive performance results over various multiyear time frames, including relative to the other EM market-cap segments. As one example, over the last two decades, EM small caps have consistently outperformed their large-cap counterparts on a rolling five-year basis (Figure 1). In our view, this suggests that over the long term, an appropriate representation of EM small caps within a larger EM allocation may help improve the long-term return potential of a diversified portfolio.

Figure 1

EM small cap has outperformed EM large cap 80% of the time

While that may not be news to most investors, many are surprised to learn that the strong return potential of EM small-cap stocks does not necessarily come with excessive volatility. We believe a common misperception surrounding EM small caps is that they are significantly more volatile than larger EM equities.

We acknowledge that there are certain environments in which EM small caps experience heightened volatility relative to larger caps, such as during during more macro-driven markets when investors are…

To read more, please click the download link below.

1Source: MSCI. | All data as of 31 December 2019.

RECOMMENDED FOR YOU

Climate change and emerging markets: Assessing opportunities and challenges
September 2020
Climate change and emerging markets: Assessing opportunities and challenges
,
Interested in structural opportunities in emerging markets? Be prepared to think differently
A new investing paradigm for emerging markets? We look at the evidence for economic development over economic progress as a key determinant in these markets.
August 2020
Interested in structural opportunities in emerging markets? Be prepared to think differently
,
Emerging markets: Navigating opportunities and risks in today’s crisis
We explore today's key emerging markets themes including the impact of COVID-19, China's evolving global relationships and an increased focus on sustainability.
August 2020
Emerging markets: Navigating opportunities and risks in today’s crisis
,
Brazil: Off the fiscal crutches, but can it walk?
Brazil is implementing an ambitious plan to pivot 180 degrees from a state-led to a neoliberal, market-driven economy. Two of our Latin America investors share takeaways from a recent research trip about Brazil's near-term growth prospects and potential to generate investment returns.
December 2019
Brazil: Off the fiscal crutches, but can it walk?
,
Kenya: Development in action
Our grassroots investors recently traveled to Kenya to learn firsthand about the country's policies and consumer markets. While the investable universe is still small, a focus on economic development and a young, hardworking population could be a formula for sustainable growth.
December 2019
Kenya: Development in action
,
South Africa: Making the best of a challenging </br>environment
Despite myriad socioeconomic challenges, consumers and business owners in South Africa are resilient and optimistic about the country’s future. Two of our emerging markets portfolio managers share insights gained on a recent grassroots research trip to Cape Town and Johannesburg.
November 2019
South Africa: Making the best of a challenging
environment
,
Top of Mind: Existential questions about value, international diversification, and China
Should investors be patient with value stocks and international equity diversification? And where do China A-shares fit in an emerging markets portfolio? Multi-Asset Strategist Adam Berger collects his thoughts along with research from colleagues across the firm.
August 2019
Top of Mind: Existential questions about value, international diversification, and China
,
EM evolution: New paths in portfolio construction
Given major market and economic changes over the past decade, it may be time to rethink EM equity and debt exposures. In this paper, we lay out simple frameworks investors can use to structure their EM portfolios given the wider range of implementation options available today. We also consider the active/passive decision and the manager selection process.
June 2019
EM evolution: New paths in portfolio construction
,

We use cookies to improve your experience on our website. To accept cookies click Accept & Close, or continue browsing as normal. For more information, visit Cookies & Tracking NoticE.