Five myths about small cap investing

Portfolio manager tackles common misconceptions about the space

Five myths about small cap investing

Dismiss international small cap opportunities at your peril.

That’s the message from Robert Beauregard, CIO and portfolio manager at Global Alpha Capital Management, the subadvisor for the Ninepoint International Small Cap fund.

Global Alpha, which has $2 billion AUM, focuses exclusively on global and international small cap portfolios and Beauregard said it is important the investors understand misconceptions around this space. He highlighted five myths he believes hinders small caps’ reputation.

1, They are more risky
Beauregard said that if you look at five previous down markets like the tech bubble in 2000, the Nifty Fifty in the 1970s, the Asian crisis in 1997, the global financial crisis in 2008 and the European debt crisis in 2011, three out of five times the international small caps did better than large.

He said: “Why is that? Well, it really has to do with diversification. Large cap benchmarks are market cap weighted and what we are seeing is when something is popular, it gets to be a very big weight in the index, whether it’s the banks in ‘07 or the tech stocks in ’99.”

He added that breaking down the MCSI reveals all 11 sectors, with the biggest industry being the Real Estate Investment Trust at less than 6%. He said: “In the banking crisis, banks were only 4% of the index so obviously we didn’t suffer as much. Less risky in downturns, more value in an upcycle.”

2, They are more expensive
While Beauregard concedes that small caps will often sell at a premium to large caps because of faster growth and better risk-adjusted returns, he said they are currently at a discount because of the move to index funds and the fact mega cap tech firms are draining so much liquidity.

He said: “At the moment, international small caps are selling for about 15x earnings; that’s a price earnings ratio that compares to 21x for the S&P500 and 18x for the large cap world index.

“That’s a discount you don’t see very often. It’s a very attractive entry point if you believe the global economic cycle is still intact.”

3, The S&P, TSX is a large cap index
Beauregard said the percentage of companies over $1 billion market cap in the S&P/TSX (93%) is not significantly higher than ISC.

He countered that in the small cap index there are almost 2,000 companies that are more than $1 billion. “If we took our entire universe, because the MSCI can’t put all 10,000 companies in the index, it would be almost 4,000 companies that have over $1 billion market cap compared to 229 [in the TSX, S&P composite]. So Canada really is a small cap index and more risky than international small cap.”

4, Small caps have weaker balance sheets
The portfolio manager branded this assertion as totally false and said companies have a much lower net debt-to-equity ratio than other peers.

Beauregard added that the total debt to total equity for the MSCI world is about 132%, while for the small cap international it’s only 91% and the SNP it’s around 120%.

He said: “They have less debt and that relates to the fact a lot of these companies are majority owner or significantly owned by families and founders, so tend to be more conservative.”

5, They don’t pay dividends
While this is probably true if you are looking at the US where yield is quite small, internationally there is a different picture because of the often historic nature of companies and the desire from families and owners for yield.

Beauregard said: “International small cap index pays a much better dividend than the S&P 500 or the NASDAQ or a lot of other indexes. At the moment, the yield on international small cap is 2.51% and that compares to the S&P 500 at 1.83% and the large cap world index at 2.34%. So you get growth returns, less risk and you also get a better dividend.”


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