International small cap
Defining a promising asset class
As the effort to draw down home-country bias within equity portfolios intensifies, non-U.S. small cap will become an increasingly important aspect of policy allocation and manager selection decisions. Until recently, most international investors worldwide have concentrated exclusively on large cap companies from developed countries particularly, companies with strong multinational brand recognition (e.g., Nestle, Toyota, etc.). Due to this common focus, macro global factors are driving much of the performance of these companies, thereby raising correlations among large caps in markets worldwide. So while home-country bias may have diminished, the potential risk and return benefits may not have been achieved.
Our belief is that the international small cap asset class will feature prominently as investors seek greater diversification by way of an expanded international equity opportunity set. As measured by its correlations to large cap in the U.S. and other regions worldwide, international small cap has remained differentiated in its performance. Non-U.S. small cap has also offered some of the highest risk-adjusted returns of any market segment. Historical performance has been strong relative to the U.S. market, and the number of international small cap products and asset flows have increased in the last five years.
Emerging markets have led growth in the non-U.S. small cap equity opportunity set as measured by the total number of companies in the Russell Global Index. Though this universe of companies is growing, it was not spared from the impact of the financial crisis and global recession. The large company/small company boundary rose to a pre-crisis high of 2.5B USD before falling to a low of 1.5B; it has recovered to 2.3B as of Russell's June, 2011 annual index reconstitution. Liquidity for international small cap securities continues to be a concern, making index replication more difficult but offering selective opportunities for actively managed products.
Major index providers employ varied construction rules, which leads to differentiated small cap index offerings. S&P uses a country-relative approach that decides the large company/small company boundary exclusively for each country, resulting in substantial differences in how small cap is defined globally. Using an S&P-like process, FTSE defines "large" and "small" on a regional basis, but this approach does little to mitigate the problem of size mismatch. MSCI, using the most complex process, combines elements of both country- and global-relative methodologies; while size mismatch is somewhat reduced with this method, it is not eliminated. Finally, Russell uses a global-relative method that defines capitalization size clearly and consistently, thereby eliminating the problem of size mismatch in the evaluation of the international small cap asset class.¹
The first section of our paper focuses on the characteristics of the international small cap asset class correlations, risk-adjusted performance, sector exposures, market capitalization and liquidity and includes an allocation simulation. The second section provides a comprehensive review of the processes major index providers (FTSE, MSCI, Russell and S&P) follow in defining international small cap, and the implications for investors.
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Russell Global ex-U.S. Small Cap
The Russell Global ex-U.S. Small Cap Index provides an accurate, comprehensive and unbiased barometer for the international (non-U.S.) small cap universe.
- Represents the true small cap market. Russell's global relative approach uses a consistent market cap break across all markets to create a clearly defined grouping of like-sized companies.
- Replicable. Our global-relative approach determines membership no complicated, multilayered calculations required.
- Deep coverage. Representing 98% of the investable universe, our Global Index reflect the performance of over 10,000 securities in 47 countries.
- Objective and transparent. Like all Russell Indexes, the index is created using a rules-based, easy-to-understand methodology.
- In line with manager expectations. Cap breaks, constituent counts and market cap range closely match how global managers view this opportunity set.
- Created by experts. As a leading index provider for the U.S. small cap market (Russell 2000), Russell combines market segment knowledge with global expertise to create the most accurate international small-cap benchmark.
For more information about Russell Global Small Cap, call a Russell representative at 1-866-551-0617 or submit your question. We'll be happy to answer any questions you may have.
1 For details on index construction and cap size analysis please refer to the full article "International Small Cap: Defining a promising asset class".
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