10 Mar 2023

Is Now the Time for Small Caps?

Investing in turbulent markets can raise a number of questions for investors. The high inflation and the rising interest rate environment in the US is particularly concerning to many. When markets are volatile and unpredictable, the only real guidance we can get is by looking back in history. Taking advantage of patterns that we have seen before can lead to long-term success. In recent years, rising interest rates have been very topical given the ultra-low rate environment experienced in the US for 30+ years.

Looking back to similar periods in history for guidance shows us that, historically, in a rising rate environment, such as the one we are currently experiencing, small caps have in the past delivered better returns than their large cap counterparts.

Average Annual Return When Rates Rise or Fall 

31 December 1978 to 31 December 2021.

Past performance is not a reliable indicator of future performance.

Based on 10-year US Treasury yields, on a rolling monthly basis, with average annual equity Index returns being based on the subsequent 1-year return to the rising or falling yield.

Sources: Furey Research Partners, S&P, London Stock Exchange Group plc – Analysis by T. Rowe Price.

What we have also observed historically is that US small cap companies have tended to lead the market recovery following a bear market. What’s more, their outperformance relative to larger companies’ counterparts has often been magnified during the early stages of recovery, as large companies have been generally slower to respond to the changing environment.

S&P 500 vs Russell 2000 – 12 Months Post Recession

Source: Strategas Securities, LLC

The VAM US Small Cap Growth Fund shows the same trend when we look back at the recent recessions.

Performance of VAM US Small Cap Growth Fund B (%) after Bear Market Events 

VAM US Small Cap Growth Fund vs Peer Sector Average

The skill that the Manager has in picking stocks that have been dragged down as a result of the prevailing market conditions is evident when comparing the VAM US Small Cap Growth Fund to the peer group over a full market cycle.

The advantages of adding a small exposure to this Fund as a satellite allocation within a focused Balanced Fund is illustrated in the chart below.

The Advantage of Adding Small Cap Exposure to a Balanced Fund

Where US small cap companies are concerned, history shows us two trends that we pay attention to:

  1. The tendency for US small cap companies to outperform their larger counterparts during periods of heightened inflation and rising interest rates.
  2.  After periods of economic recession, US small cap companies have generally led the market recovery – often going on to outperform larger companies over multiple years.

We believe that the VAM US Small Cap Growth Fund should be a consideration for any investor wanting exposure to this interesting market sector.

Past performance does not predict future returns. The price of shares can go down as well as up and may be affected by movements in the rates of exchange. 

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