When it comes to small-cap equities, profitability matters. Over the past 25 years, the S&P SmallCap 600® has outperformed the Russell 2000 by almost 1.7% on an annual basis. A key driver of this outperformance was the quality bias that comes from the profitability screen that is built into the S&P SmallCap 600. What happens when that same methodology is applied to small caps in other markets?
1. What are the characteristics of small-cap stocks and how have market participants used them traditionally?
An important characteristic of small-cap stocks is that they are considered growth stocks, because they have a higher potential for growth. Historically, small caps have outperformed large caps over the long term. Studies have shown that stocks with attractive price valuation and good growth prospects tend to outperform. Small-cap stocks also tend to be focused more domestically, offering a purer local play on Brazil growth. Furthermore, in smaller markets like those in the Latin American region, small-cap indices can actually help develop the overall market by drawing attention to the smaller stocks, which may help create more demand for direct or indirect investment, either through individual stocks or through index-based strategies tracking small-cap indices.
2. The S&P/B3 SmallCap Select Index is part of a broader index series, the S&P Global SmallCap Select. What type of small-cap stocks do these indices track?
Small cap can be defined based on either a fixed market size or on a relative size range, the latter being what we use in Brazil. We start with a broad view of the market, with our country index taking into account all Brazilian companies that trade on B3 and meet the minimum size and liquidity criteria. We segment those by total market cap and then take the cumulative weight of the floatadjusted market cap to categorize the different segments. We use 70%, 15%, and 15%. The top 70% represents the large caps, the next 15% the mid caps, and the bottom 15% the small caps.