Global vs. ASX Small Caps: What's the difference?

Two things I love about investing and my role at Livewire are small caps and hearing from our readers. So when we received an email from Chetan asking about the difference between Aussie and Global Small Caps, it seemed like a great opportunity to combine both.

Chetan had two parts to his question: what are the key differences between the two universes, and how do they sit alongside an already established core portfolio? In this article, I’ll try to shed light on both questions with help from Ophir Asset Management’s Head of Research, Luke McMillan, and Sebastian Ferrando from wealth management firm Koda Capital.

What is a small cap?

It sounds simple, but definitions vary widely. We frequently cover Australian small caps only to hear that these businesses don't feel "small". 

Plumbing supplier Reece (ASX: REH), for instance, sits inside the S&P/ASX Small Ordinaries Index (XSO) despite boasting an $11 billion-plus market cap - we're not talking about your classic speccies here.

In Australia, the official small-cap benchmark is the S&P Small Ordinaries Index (XSO), while offshore the primary reference is the MSCI World Small Cap Index - we'll dig into the composition a bit further on.

On the role and rationale for inclusion, Sebastian Ferrando says small-cap exposure is common in diversified portfolios and can provide an alternative source of returns over time. For a growth portfolio, he says clients will have an exposure somewhere between 1 and 4 per cent. 

"Rising rates are tough for smalls but flat-to-falling rates are a bit of a tailwind. They're a good insert for risk-on portfolios. When they're off, they're awful. But when smalls are on, they often rip, and fast. If the risk tolerance is there, and the time frame too, they can be a good add."

How have small caps performed over the long term? 

The chart above comes courtesy of Ophir Asset Management's Head of Research, Luke McMillan, and shows the performance of Australian and global small caps since the end of 2021. 

McMillan notes that while Australian small caps held their ground during the 2000s commodity boom, global peers have dominated the post-GFC era.

"Since their common total return inception in the year 2000, Aussie Smalls have returned 5.7% versus 9.2% for Global Smalls - or a 322% versus 867% cumulative return. It’s paid not to have a home bias in Aussie Smalls for the last decade and a half," explains McMillan.

Ophir runs dedicated strategies across both universes, with the Ophir Opportunities Fund returning 22.7% p.a. since inception and the Ophir Global Opportunities Fund returning 17.43% p.a. since inception. 

Much of the divergence in index-level performance stems from sector composition: offshore tech and healthcare deliver structural secular compounding, while the domestic index remains tethered to cyclical commodity swings.

The image above outlines some of the differences - Australia's large exposure to materials being a key point to note.

"No big surprises here, but just like their big brother markets, Aussie Smalls are big in the Materials sector at a ~25% weight compared to a more pedestrian ~7% for Global Smalls. Digging stuff out of the dirt is not just limited to BHP and RIO in Australia, clearly," says McMillan.

Look deeper into that Australian resources exposure, and a single commodity dominates.

"Gold companies make up ~12% of the Aussie Small Cap market compared to just ~1% in Global Smalls. For Aussie Small Cap fund managers that manage against the benchmark, given the volatility of gold, this almost forces you to address how you are going to play that market. Holding none while gold rips means perhaps months, if not years, of underperformance."

By contrast, global small caps tilt heavily toward technology (roughly 13%, double the local market), healthcare, and industrials.

Size is another factor - going global means exposure to larger companies.

"Some of the biggest fishes in the Global Small Cap pond are routinely in the A$10-30bn market cap range, which would make them big Mid Caps in Australia or even small Large Caps here."

Greater scale brings liquidity, allowing fund managers to enter and exit positions without moving the underlying share price. 

Ferrando explains that, in terms of exposure, larger company size in global small caps also affects index quality and the role of passive funds.

"A decent number of smalls in the US are ASX 50 companies, which drags the passive index quality up."

Narrowing down the universe

Scale creates a serious practical hurdle for an individual investor considering DIY stock picking. The global small cap universe is roughly 20 to 25 times larger than Australia's, covering thousands of companies across multiple continents.

“For most investors that will mean filtering it usually on one or more quantitative metrics to get at the types of companies you want to look at. Often because of the sheer size of the universe, it is one better handed over to professionals who have the time, resources and experience to grapple with its enormity,” says McMillan.

Market mechanics also differ offshore, particularly in the US, where hedge funds and short selling feature far more heavily on share registers. McMillan notes that factor positioning, leverage, and short squeezes can drive short-term price swings regardless of underlying fundamentals:

"Sentiment, positioning, and liquidity can be just as important - if not more so in the short term - than the earnings direction of the company."

McMillan highlights dual-listed life tracking app Life360 (ASX: 360) as a textbook case: once it added a US listing, its trading volatility and earnings reactions surged as offshore algorithms and hedge funds entered the fray.

Getting exposure

Investors have three main pathways beyond picking individual companies. As you would expect, you can choose a passive, active, or systematic approach.

• Active Managers: Given the vast, under-researched nature of global small caps, active stock picking can uncover mispriced opportunities.
• Passive ETFs: Low-cost options tracking the MSCI World Small Cap or ASX Small Ordinaries deliver straightforward beta, though they retain benchmark sector skews.
• Factor-Screened ETFs: "Quality" or "equal-weight" smart-beta ETFs filter out unprofitable or debt-heavy businesses, smoothing drawdowns.
  

The table below shows a sample of both passive and factor-screened ETFs available in Australia. Note these have been shown for illustrative purposes and should not be viewed as recommendations. 

My takeaways

I was aware of the key differences between Australian and Global Small Caps; however, what stands out to me is the material difference in the scale of the global small cap market and, by contrast, the narrow nature of Australian small caps - they're very different propositions. 

Clearly, if you want exposure to resources, you get that in spades in Australia, and if you're going to hunt outside our major miners, it seems like a job best done by an expert (unless mining stocks are your specialty).

With the concentration in US mega-caps, an allocation to global small caps is a more balanced way to introduce diversification whilst still getting exposure to decent-sized companies.  

What is your view? 

Do you invest in global or Australian small caps? How do you do it, and what has your experience been? Let us know in the comments below