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Revisiting Global Small Cap (July 2010)

The small cap as a source of equity risk premia has been well documented in finance literature. Although small-cap stocks are often perceived as risky relative to their large-cap counterparts, they have other characteristics that may provide an opportunity for portfolio diversification and return enhancement. In particular, moving beyond the universe of large- and mid-cap stocks into the small-cap segment triples the opportunity set in terms of number of stocks available for investors. Also, there have been pronounced performance disparities between the large- and mid-cap segments and small-cap segments of equity markets. This has motivated institutional investors to seek broader exposure and to make strategic portfolio allocations to small-cap stocks, which is evident from the growth in initial funding to small cap mandates. This research insight presents the characteristics of global, small-cap stocks relative to large- and mid-cap stocks, reviews the role that global small-cap stocks can play for portfolio diversification and return enhancement and examines different investment processes to capture the small-cap premium by comparing active versus passive strategies.