Seeking diversified exposure to international small cap companies

The international small cap strategy invests primarily in common stocks of companies with smaller market capitalizations located in developed and emerging markets outside the US. The portfolio normally invests at least 80% of its total assets in equity securities of companies with smaller market capitalizations. Smaller market capitalization companies are companies with market capitalizations that do not exceed the highest market capitalization of a company within the portfolio’s benchmark, the MSCI ACWI ex USA Small Cap Index (Gross), at the time of purchase. Some of these companies, although small by US standards, might be large companies in their local markets. The portfolio may continue to hold securities of a company that appreciate above the smaller market capitalization threshold and thus may from time to time hold less than 80% of its total assets in equity securities of companies with smaller market capitalizations. The portfolio may invest in a wide range of industries.

Benchmark
MSCI AC World ex USA Small Cap
Inception
November 30, 2014
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Strategy overview

The portfolio managers discuss our International Small Cap strategy.

Portfolio managers

Quantitative Portfolio Manager
Head of Quantitative Research
Quantitative Portfolio Manager
Quantitative Portfolio Manager
Quantitative Portfolio Manager

Performance

QTD YTD 1 year3 years5 years Since inception
Strategy (gross) 6.0%19.7%23.7%14.2%6.6%8.4%
Strategy (net) 5.9%19.1%22.9%13.4%5.9%7.5%
MSCI ACWI ex USA Small Cap 2.2%9.5%10.6%5.4%3.6%5.7%
QTD YTD 1 year3 years5 years Since inception
Strategy (gross) 6.0%19.7%23.7%14.2%6.6%8.4%
Strategy (net) 5.9%19.1%22.9%13.4%5.9%7.5%
MSCI ACWI ex USA Small Cap 2.2%9.5%10.6%5.4%3.6%5.7%
QTD YTD 1 year3 years5 years Since inception
Strategy (gross) 8.3%12.9%22.5%16.4%5.8%7.8%
Strategy (net) 8.1%12.5%21.6%15.7%5.0%7.0%
MSCI ACWI ex USA Small Cap 2.2%7.2%11.5%8.6%3.1%5.5%
QTD YTD 1 year3 years5 years Since inception
Strategy (gross) 8.3%12.9%22.5%16.4%5.8%7.8%
Strategy (net) 8.1%12.5%21.6%15.7%5.0%7.0%
MSCI ACWI ex USA Small Cap 2.2%7.2%11.5%8.6%3.1%5.5%
Fund 20222021202020192018201720162015
Strategy (gross) -9.9%22.3%4.3%21.6%-20.4%36.4%4.6%6.1%
Strategy (net) -10.5%21.5%3.6%20.7%-21.2%35.1%3.6%5.0%
MSCI ACWI ex USA Small Cap -19.6%13.4%14.7%22.9%-17.9%32.1%4.3%3.0%
Strategy (gross)
Strategy (net)
MSCI ACWI ex USA Small Cap
20222021202020192018201720162015
-9.9%22.3%4.3%21.6%-20.4%36.4%4.6%6.1%
-10.5%21.5%3.6%20.7%-21.2%35.1%3.6%5.0%
-19.6%13.4%14.7%22.9%-17.9%32.1%4.3%3.0%

Portfolio (as of August 31, 2023)

Benchmark: MSCI ACWI ex USA Small Cap
Asset Allocation
Strategy
Stocks 98.6%
Cash 1.4%
Strategy Characteristics
Strategy Benchmark
No. of holdings 167 4385
Weighted avg. market cap (US $MM) $2,355 $1,925
FY2 price/earnings 6.8 11.8
Price/book value 0.9 1.4
Dividend yield (%) 4.8 2.9
TOP 10 HOLDINGS
Security Country Active weight*
Centrica United Kingdom 2.1%
KPIT Technologies Ltd. India 2.0%
Power Finance Corp. Ltd. India 2.0%
Mitsubishi Motors Corp. Japan 2.0%
Sojitz Corp. Japan 1.8%
Sok Marketler Ticaret AS Turkey 1.7%
Bper Banca Italy 1.7%
Banco BPM SpA Italy 1.6%
Radiant Opto-Electronics Corp. Taiwan 1.6%
Electric Power Development Co., Ltd. Japan 1.5%

A “weighted average” measures a characteristic by the market capitalization of each stock. Price/book ratio is the weighted average of the price/book ratios of all the stocks in a portfolio. The P/B ratio of a company is calculated by dividing the market price of its stock by the company’s per-share book value. The price/earnings ratio is the weighted average of the price/earnings ratios of the stocks in a portfolio. The FY2 P/E ratio is a forward P/E ratio using a next-twenty-four months EPS estimate in the denominator.

*Active defined as Portfolio weight minus MSCI ACWI ex USA Small Cap Index weight. Holdings are subject to change.

SECTOR WEIGHTS
Sector Strategy Benchmark
Industrials 19.7% 20.8%
Financials 15.3% 11.0%
Consumer Discretionary 14.0% 11.8%
Materials 11.6% 11.8%
Information Technology 11.4% 11.8%
Utilities 6.7% 3.1%
Consumer Staples 5.1% 6.1%
Real Estate 4.5% 8.8%
Communication Services 4.1% 3.8%
Energy 3.1% 4.1%
Health Care 2.4% 6.9%
Equity Funds 0.9% 0.0%
TOP 10 COUNTRIES
Country Strategy Benchmark
Japan 23.6% 21.1%
United Kingdom 9.2% 9.7%
South Korea 7.2% 4.4%
India 7.1% 7.4%
Taiwan 7.0% 5.9%
Italy 6.1% 2.3%
Canada 5.8% 7.1%
Australia 4.7% 6.2%
Turkey 4.0% 0.6%
Sweden 2.7% 3.3%
Regional Allocation
  • Pacific 30.1%
  • Europe – other 28.3%
  • Emerging Asia 26.8%
  • North America 5.8%
  • Emerging Europe, Middle East, Africa 4.8%
  • Emerging Latin America 1.7%
  • Multi Region All Country 0.9%
  • Developed Middle East 0.2%

Commentary (As of August 31, 2023)

Highlights

  • Global equity markets paused their rally in August, dipping slightly lower for the month. Expectations of a higher-for-longer interest rate environment and apprehensions surrounding China's slowing economy tempered market enthusiasm.
  • Economic signals in developed economies are mixed. In August, US wages rose year-over-year and employers added jobs, yet the unemployment rate crept up to 3.8%. The core personal consumption expenditures price index rose 0.2% in July, the smallest uptick since late 2020, yet inflation-adjusted consumer spending experienced its greatest increase year-to-date. Euro area inflation for the year-to-date through August period was 5.3%, well exceeding the central bank's 2% policy target, although consumer price increases excluding energy and food cooled.
  • We believe that international small caps, and international small cap value stocks in particular, still have some “catching up” to do with larger cap and growth stocks from a valuation perspective.

Portfolio attribution

The Portfolio modestly underperformed the Index during the month. To evaluate stocks in our investable universe, our multi-factor quantitative model employs four bottom-up factor categories – valuation, earnings growth, technical indicators, and competitive strength – and two top-down factor categories assessing macroeconomic and country aggregate characteristics. All of our alpha factor categories delivered positive returns in August. The strategy’s value factors once again produced positive monthly returns, and value remains the best-performing factor in 2023 and over the last twelve months. Our earnings growth and technical factors also posted positive returns last month and returns for both are now positive on a year-to-date and last-twelve-months basis as well. Competitive strength generated positive returns in August, and it is the second-best performing factor group year to date and over the last twelve months. Our macroeconomic and country aggregate factors were positive indicators in August due, in part, to their positive views on Japan and Turkey, markets that outperformed the Index last month. All factor groups remain positive on an inception to date basis.

Economic outlook

Economic signals in developed economies are mixed. In August, US wages rose year-over-year and employers added jobs, yet the unemployment rate crept up to 3.8%. The core personal consumption expenditures price index rose 0.2% in July, the smallest uptick since late 2020, yet inflation-adjusted consumer spending experienced its greatest increase year-to-date. Euro area inflation for the year-to-date through August period was 5.3%, well exceeding the central bank's 2% policy target, although consumer price increases excluding energy and food cooled. Central bank officials must assess if slowing growth can sufficiently reduce inflation or if further rate hikes are warranted. We expect unemployment to rise in the US, UK, and Europe in the first half of 2024 as credit conditions tighten further. The Bank of Japan stated its economy may be reaching a turning point in its 25-year battle with deflation. Official measures showed Japanese demand outpacing supply for the first time in four years.


All eyes are on China as the world’s second-largest economy grapples with a slumping property sector and slowing real GDP growth. China is deploying measures to shore up its property market and address vulnerabilities in its financial system and currency, yet investors remain concerned about the repercussions of flagging Chinese activity on the greater global economy.

Investment outlook

We believe that international small caps, and international small cap value stocks in particular, still have some “catching up” to do with larger cap and growth stocks from a valuation perspective. On a forward price to earnings basis, international small caps have traded at a median 1.3x multiple premium to large caps over the last 20 years. As of the end of last month, however, international small caps are still trading at a slight discount despite outperforming in August. During similar periods historically, small caps have gone on to outperform over the following twelve months. Within our international small cap alpha model, value factors receive the largest weight on average. The MSCI ACWI ex US Small Cap Growth Index traded at a 17.7x forward P/E multiple compared to 10.1x for the MSCI ACWI ex US Small Cap Value Index as of 8/31/2023, a 75% premium. Even if the U.S. Fed is near the end of its interest rate hikes, interest rates should remain elevated for some time. A higher cost of capital should translate into a continued preference for value stocks.

The market commentary expresses the portfolio managers’ views as of the date of this report and should not be relied on as research or investment advice regarding any stock. These views and the portfolio holdings and characteristics are subject to change. There is no guarantee that any forecasts made will come to pass. The securities identified and described above do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. Past performance does not guarantee future results. For a description of our performance attribution methodology, or to obtain a list showing every holding's contribution to the overall account's performance during the quarter, please contact our product manager, Kevin Moutes, at 310-231-6116 or [email protected].