Despite the high certainty of global small caps out-performing global large caps (aka the ‘small cap effect’) over the long term, Australian institutional and wholesale investors have been reluctant to allocate equity capital outside the global large caps and global emerging markets. As a matter of fact, we find that there is a greater propensity to allocate capital to global private equity than to global small caps. Our analysis shows that a modest allocation to global small caps can:
- Substantially increase the investment opportunity set and potential for adding alpha,
- Provide demonstrable diversification benefits due to idiosyncratic attributes,
- Offer significant growth advantage over large caps and,
- Offer greater liquidity than global private equity.
Global small cap investing has strong merits for Australian investors, both from return-enhancing and risk-diversification perspectives. Our analysis shows that global small caps are underpinned by unique fundamental drivers that are structural in nature. Importantly, this fundamental insight means long-term investors can rely on the critical outperforming attributes of the asset class with greater certainty.