As global markets evolve, small-cap stocks are emerging as a compelling opportunity for investors, particularly those in Australia, according to Sadhvi Gupta, Executive Director for Quantitative Investment Strategies at Goldman Sachs Asset Management.
Australian investors have traditionally concentrated on large and medium-cap companies, either through managed funds or direct stock investments. However, when it comes to international equities, most Australian managers rely on the MSCI ACWI ex Australia Index, which excludes the bottom 15% of the investable universe. This exclusion results in missed opportunities in the global small-cap sector, where potential for significant returns lies.
Small-cap stocks, often in their growth phase, are nimble and innovative, adapting quickly to market changes. With inflation rates cooling globally and the possibility of central banks cutting rates later this year, smaller companies may outperform their larger counterparts during this recovery phase.
Yet, navigating the global small-cap landscape presents challenges. The universe is vast, with significant individual volatility and a plethora of data to sift through. For instance, the MSCI World Small Cap Index encompasses 4,130 stocks across 23 developed markets, representing about 14% of the investable market in each country.
Sector allocations within the index are diverse, with Industrials (20.5%), Financials (15.0%), Consumer Discretionary (13.1%), Information Technology (11.0%), and Health Care (9.5%) holding the largest shares. Geographically, the largest representations come from the United States (60.3%), Japan (12.3%), the United Kingdom (5.3%), and Canada (3.8%).
Despite the inherent volatility of small caps, they have historically performed well during economic recoveries. With current valuations at historic lows—19% below the historical average and 44% below the 2020 peak—there is a significant opportunity for investors. As of December 31, 2023, small caps are trading at a discount, making this an opportune time for investment.
For those looking to tap into this potential, a systematic approach is essential. The Yarra Global Small Companies Fund, managed by Goldman Sachs Asset Management, employs a quantitative method using AI, big data, and machine learning to navigate the extensive small-cap universe. The fund's strategy includes fundamental, bottom-up research to identify high-quality business models, assess financial positioning, management quality, and industry outlook, and uncover sources of alpha.
By leveraging proprietary data and global market insights, the fund aims to identify fundamentally undervalued companies, ensuring strong long-term performance. Given the complexity and risk profile of small caps, selecting a skilled manager who can adeptly analyze and capitalize on these opportunities is crucial.
