International Small Cap:Defininga Promising Asset Class

Abstract

The benefits of international equity portfolio diversification have been well documented. Until recently, however, most investors worldwide have concentrated exclusively on large cap names from developed countries (Ferreira and Matos [2006]; Kang and Stulz [1997]). This focus on large, often multinational companies with strong brand recognition benefited investors as they began to reduce the home-country bias within their portfolios. Unfortunately, as often happens when a market, sector, or individual company becomes widely followed, the prospective benefits to be gained–risk reduction, greater return potential, or both–have declined. Macro global factors common to developed large cap companies now explain much of their performance, while increased analyst coverage and more transparent reporting have reduced information inefficiencies (Yan [2009]). All of this has led to more highly correlated performance and lessened the magnitude of the potential benefits that investors were seeking by diversifying their portfolios away from a single country or region.