CASE STUDY

Global Small-Cap Equity

Australian Superannuation Fund | 2021

Engagement at a glance

Client Country/Type: Australian Superannuation Fund
Year: 2021
Asset Class: Global Small-Cap Equity
Mandate Size: AUD 100 million
Mandate Geography: Global
Mandate Type: Separate Managed Account
Service Provided: Manager Search
Investment Objective: High alpha versus global small-cap benchmark

 

Global Small-Cap Equity

Client-specific concerns

The client, an Australian superannuation fund, engaged bfinance to identify high-alpha global small-cap equity strategies to complement its existing roster of large- and all-cap managers investing globally across developed and emerging markets. The client had identified small-cap stocks as a market segment in which the portfolio was underweight and, with this area being known for pricing inefficiency (and therefore alpha potential), the client had opted to address the imbalance through a dedicated allocation. Although the superannuation fund intended to keep the allocation relatively small in the context of the overall equity portfolio, its objective was to identify strategies that could make an outsized positive contribution to aggregate portfolio returns.

 

Outcome

  • Identifying ‘new’ strategies: the client favoured established global small-cap strategies, but its investment team was also interested in exploring newer offerings. The bfinance approach—casting a wide net across the manager universe—was therefore well-suited to the resulting search, which was flexible enough to include firms that managed individual US and International (ex-US) small-cap offerings but did not currently have (or actively market) their global small-cap capabilities. The search yielded several such proposals, primarily from firms that had nascent global track records (<3 years), but strong, long-term track records in managing standalone US and ex-US small-cap strategies.

  • Conducting style analysis: looking beyond the managers’ own espoused investment styles, bfinance analysed the fundamental metrics of their portfolio holdings to determine each manager’s underlying style characteristics. Many investors assume that small-cap investing is growth-oriented—and we observed a prevalence of strategies with this style bias. However, asset owners should be cognisant that most global small-cap strategies (whether growth, value or otherwise) are likely to contribute growth characteristics at an aggregate global equity portfolio level against a broad, all-cap benchmark due to the often-higher growth rates exhibited by smaller companies.

  • Examining portfolio fit and complementarity: bfinance conducted ‘combination’ analysis, evaluating how each of the prospective small-cap managers under consideration would fit alongside the asset owner’s incumbent all-cap equity managers. Although past and current overlap can be easily determined, any potential for future overlap deserves investors’ close attention: small cap managers often exhibit a propensity to let their winners ‘run’ into the mid-cap (and sometimes even large-cap) segments, which raises the risk of unexpected overlaps occurring across equity portfolio holdings.

  • Adjusting for investment preferences: bfinance customised the search to reflect the client’s investment preference for fundamental strategies that offered evidence of managers’ abilities to deliver excess returns within the context of strong risk-adjusted return profiles (IR > 0.5). The asset owner also wanted to see meaningful ESG integration by the prospective manager and apply its own exclusions on companies producing tobacco, controversial weapons and thermal coal.

Our specialist says

  • While many global equity strategies are labelled as having an ‘all cap’ approach, we find that their exposure is often entirely focused on large- and mid-cap segments. An increasing number of globally minded asset owners are adding dedicated exposure to global small caps, seeking specialist external managers to cover this universe of more than 6,000 companies. Our searches have identified more than 80 live strategies in the global small cap space; we have also detected an interesting undercurrent as managers with long-term expertise investing regionally in small caps launch new strategies with a more global focus. Across the small-cap manager universe, we see an abnormally high percentage of strategies outperforming their relevant benchmarks, furthering the case that this area is well-suited to active management.

}