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September 2017

Small cap outperformance

Over the past year, small capitalization indexes have outperformed their large capitalization counterparts. Although the reasons for this rally are varied, attractive return on assets of emerging market (EM) small-cap constituents and specific domestic drivers have supported this trend. We look at Brazil, Japan, and India as particular observations of this trend that should be monitored going forward.

Many small-cap indexes have outperformed their large-cap peers across the globe over the past year. Although the exact reasons for this trend may vary, this global theme has been amplified in select countries. Within emerging markets (EM), particularly companies in the MSCI Brazil and India indexes, small-caps have benefited from structural reforms and improving local economies. Additionally, a historical breakdown of EM companies globally shows why this outperformance may have occurred: small cap EM companies are generally more efficient than their developed market (DM) peers, as measured by their return on assets.

Relative performance of small cap over large cap for Japan, India, and Brazil

Relative performance of small cap over large cap for Japan, India, and Brazil

Source: Thomson Reuters, BlackRock, as of August 8th, 2017. Notes: The indexes include the MSCI Japan Index, MSCI Japan Small Cap Index, MSCI Brazil Index, MSCI Brazil Small Cap Index, MSCI India Index, MSCI India Small Cap Index. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

 


EM small caps are generally more efficient than DM small cap peers

EM small caps are generally more efficient than DM small cap peers

Source: Bloomberg, EPFR Global, UBS Estimates. Note: Company data for DM and EM is represented by the MSCI World Index and MSCI Emerging Markets Index, respectively. The company percentile is based on the companies' average market capitalization between 2013 to 2015. The DuPont analysis measures operational efficiency and financial leverage. The definitions are: net margin = (net income / revenue), asset turnover = (revenue / assets), return on assets = (net income / assets), leverage = (assets / equity), return on equity = (net income / equity).

 


India

The country has benefited from the general uptick in global growth and lower oil prices, but the domestic story has been particularly constructive. Indian small-cap companies have benefited as they tend to be more locally driven in nature with high exposure to consumer discretionary. Sector composition differences amongst small and large/mid showcase this point. On the economic front, exports have increased along with regional trade even as trade deficit widened on pickup in gold and capital goods imports. Risks include implementation of the Goods and Services Tax (GST).

Brazil

Brazilian equities and the real have bounced back sharply this year. Legislative reforms have helped improve the economy, including passing a government spending cap, labor reforms, and phasing out the inflationary policies of the previous Lula-administration regulations. These developments have stabilized the economy and led the real to appreciate against the U.S. dollar over the last two years. Brazil has also rebalanced the external side of its economy, helping to reduce the sensitivity to global factors like commodity price swings and global liquidity conditions.

Japan

Economic growth has accelerated amid a rebound in global trade and strong domestic demand at home. Japanese small cap company revenues tend to be more domestically oriented relative to large cap companies, and the structural reform agenda, monetary policy, and economic outlook are all supportive. Domestic demand is supported by wage growth near 15-year highs, however it’s still slow enough not to erode corporate margins. Risks include potential yen strength, however this should affect small cap companies less than large cap companies, and a general slowing in global growth.

Regional small and large cap returns

CountryStyleIndexYTD Return ($)Largest Sector Exposure
India Large Cap
Small Cap
MSCI India Total Return Index
MSCI India Small Cap Index
30%
42%
Financials
Consumer Discretionary
Brazil Large Cap
Small Cap
MSCI Brazil 25/50 Index
MSCI Brazil Small Cap Index
14%
35%
Financials
Consumer Discretionary
Japan Large Cap
Small Cap
MSCI Japan Index
MSCI Japan Small Cap Index
12%
17%
Industrials
Industrials
Germany Large Cap
Small Cap
MSCI Germany Index
MSCI Germany Small Cap Index
17%
35%
Consumer Discretionary
Industrials
U.K. Large Cap
Small Cap
MSCI United Kingdom Index
MSCI United Kingdom Small Cap Index
13%
20%
Financials
Consumer Discretionary
China Large Cap
Small Cap
MSCI China Index
MSCI China Small Cap Index
36%
14%
Information Technology
Consumer Discretionary
EAFE Large Cap
Small Cap
MSCI EAFE Index
MSCI EAFE Small Cap Index
17%
21%
Financials
Industrials
EM Large Cap
Small Cap
MSCI Emerging Markets Index
MSCI Emerging Markets Small Cap Index
25%
20%
Information Technology
Materials

Source: Bloomberg, as of July 31st, 2017. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index returns do not represent actual iShares Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com.

 


Summary

Small cap returns are notable for both the size and broad performance across regions. Strong fundamentals and local reforms in select countries may further support small cap outperformance. Potential small cap opportunities in select countries are accessible through iShares country fund suite.