Global microcaps: your large cap exposure’s perfect match

Is your global large cap exposure all alone? Sitting within your portfolio with no help for the bad times, no partner to help make the good times even better?

We have a strong candidate to join your large caps on the wealth creation journey – one that ticks a lot of boxes and might even get along with the in-laws.

Global microcaps is an asset class that very few fund managers globally offer, so it would be no surprise to us if you haven’t considered adding them to the ‘family’.

In fact, in our experience very few Australian institutions already have exposure to global microcaps. The US is further progressed, with interest from large foundations and endowment funds more common.

We think the gap will narrow in the years ahead.

Perhaps the reason for the hesitation domestically is the perception that global microcaps are tiny companies. But, businesses within the global microcap universe are considered companies with market caps of up to US$1bn.

Domestically, think Appen, GrainCorp, Collins Foods or Blackmores – in a global context, microcaps are more akin to an Australian small cap.

Why global microcaps may be the perfect match

Strong performance sits at the top of the checklist. The evidence shows that microcaps are the best performing segment of global developed markets.

Below you see two log-scale charts showing the outperformance of microcaps in the US and the UK. The charts also highlight one of the most compelling attributes – that is the consistency of the outperformance across long periods of time.

But is the pay-off higher risk?

Well, the evidence shows this is not always the case. Microcaps can indeed lower systematic portfolio risk because this is a segment of the market that marches to the beat of its own drum.

Microcaps have their own unique cycle and global microcap portfolios tend to be less US centric – only 20% of our global microcap portfolio is in the US.

A great example is the recent market volatility caused by COVID-19. Below you can see on the right a 50/50 mix of Spheria’s Global Microcap Fund blended with the MSCI World Index. The result is significantly reduced volatility when compared to large caps alone.

Since the Funds’ inception, blending Spheria Global Microcap with a mainstream global manager or an international equities ETF, would have increased the equity portfolios total return, and reduced its volatility.

Microcaps tend to oscillate around large caps depending how the economy is performing, making them more negatively correlated with Government Bonds and adding to the diversification benefits. Our analysis shows that adding Global Microcaps to your equity portfolio will improve its diversification more than simply adding further to your large cap manager line-up.

What’s Global Microcaps Love Potion Number 9?

There are many attractive attributes that characterise this investment universe.

First, 51% of the MSCI World Microcap Index has no sell-side coverage.

Most investors know larger companies pay bigger fees that attract more investment banks and subsequently attract more coverage. So, many smaller companies get ignored by investment banks and hence fund managers don’t notice them to the same extent.

For the few who do specialise in searching the world for global microcaps, it makes undiscovered gems easier to find. It also means those few investors get unparalleled access to management – we are typically speaking to the CFO or above (quite often the founder). In global large caps the majority of fund managers get relegated to an investor relations executive.

The second, is a universe of fat tails.

Below we’ve charted the 3 year returns of all constituents in the S&P 500 against the MSCI World Microcap Index.

You can see just how the big the global microcap universe is, compared to the S&P 500. But what’s even more exciting to us as fund managers is the large fat tails which give active stock pickers greater avenues to generate strong alpha and differentiate themselves from the benchmark, providing real value for clients.

Finally, Global Microcaps offer far greater alignment with investors. Insider ownership is widespread within the large microcap universe and is something that we think is very attractive.

The research shows companies with higher insider ownership tend to do better. Not only is the greater alignment a strong incentive, but companies with high insider ownership can afford to take a longer term vision, placing them at an advantage over many competitors. This longer term perspective also translates into better social and environmental ESG metrics. We think that is a major advantage over the long-run.

Your large caps needn’t be lonely anymore

On the journey of wealth creation, your large caps need a partner, and we think global microcaps provide the perfect match.

When blended with large caps, this is an asset class that may not only help boost returns, but also it may help reduce risk.