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International small-cap stocks are in the doldrums – a historic slump, in fact.

Since 2022, global non-U.S. small-cap stocks have had a rough ride falling 7 per cent in 2022 and 11 per cent in the first half of 2023 compared with large-cap stocks. While this decline is historic, Nikhil Rastogi, a portfolio manager with Kabouter Management LLC, says the last time there was such a big drop, it was followed by a sharp rise.

Data from Chicago-based Kabouter, an investment-management firm focusing on public small-cap companies outside the U.S., notes that following the 2007-08 global financial crisis – when non-U.S. small-cap stocks fell 16 per cent and 9 per cent in comparison to large-cap stocks on a rolling two-year basis – they then rebounded 4 per cent and a whopping 42 per cent in 2009 and 2010, respectively.

Globe Advisor interviewed Mr. Rastogi recently about the outlook for this asset class.

Why are small caps facing a historic decline?

Small caps underperform when the economic environment is challenged because small-cap companies tend to be less diversified in terms of exposure to different regions and products. Sometimes, they have too much dependency on one customer. When economic headwinds are high, like they are now, these companies see a bigger impact on their earnings. Also, investors also move capital to large caps from small caps because of perceived safety. These two factors lead to the underperformance of small caps.

What has happened in the past with small-cap stocks?

In the past 20 years, there are just two periods, including this one, in which small caps have underperformed compared with large caps two years in a row. The last period was around the global financial crisis, when again, economic headwinds were great. The asset class does well over the long term [with annualized 20-year returns of 8.49 per cent, versus 6.66 per cent for large caps]. These periods of underperformance in the past are followed by a sharp rebound.

What is your outlook for the sector?

We do not have a view on how long this underperformance will continue. If you’re taking a five-year view, you have a very high chance that you will generate better returns than large caps. We focus on the highest quality companies – the ones we think will be able to withstand those chronic headwinds, companies that are not dependent on external funding for their growth. So, companies that have strong balance sheets, those companies, even if asset flows are unattractive, even if their share price has underperformed – as long as they’re going to grow their earnings.

Are there particular sectors that are promising right now?

Issues continue to be inflation, interest rates and economic growth. You ideally need companies with good pricing power that can pass on the costs to their customers. Companies that are not too leveraged so that interest rate increases don’t hurt them too much. And companies that sell a product or service for which demand is not dependent too much on how the economy is doing.

One sector that meets a lot of those criteria would be information technology. With a recession, companies continue to invest in more technology and move their services to the cloud. We are already seeing the impact of artificial intelligence on various businesses. These require investments in semiconductors. So, that’s a secular theme that ticks a lot of boxes because these companies have recurring revenue, pricing power and long-term demand continues to grow. Most of our picks in Canada have been more exposed to technology.

This interview has been edited and condensed.

– Gillian Livingston, Special to the Globe and Mail

Must-reads from Globe Advisor this week

How parents are saving for kids’ education amid rising costs

Some Canadian parents are “stretching themselves thin” to save for their children’s education amid decades-high interest rates and a higher cost of living, according to a recent survey. But advisors say there are strategies to lessen the financial burden while still making the most of the registered education savings plan (RESP). An Embark Student Corp. survey of 1,000 parents released in June found that 73 per cent felt it has been harder to save given higher prices and living expenses. More than half (52 per cent) of survey participants said they’d go into debt to pay for their child’s education. Kelsey Rolfe reports.

Why more high-net-worth individuals are investing in art

Investing in artwork is gaining steam among the ultra-high-net-worth set. According to the annual Knight Frank Wealth Report, a worldwide study that reviews trending asset classes among the wealthy, investing in art increased by 29 per cent last year. Art is also ranked as the report’s top investment of passion. Samantha Sykes, senior investment advisor with Sykes Wealth Management at Raymond James Ltd. in Toronto, says some of her clients hand-pick art collections to house on their walls but also have an eye on those paintings increasing in value, eventually earning them money to put toward their retirements. Deanne Gage explains.

Why this $20-billion money manager believes a market rally later this year could bring strong returns

September is traditionally a tough month for financial markets, and this year will likely be no exception if the volatility experienced in August is an indication, says money manager Sadiq Adatia. But the chief investment officer at BMO Global Asset Management says the rest of the year could bring strong returns for certain companies or sectors that may have sold off in recent months. Brenda Bouw asks him what he’s been buying and selling.

How to navigate the financial repercussions of moving kids to private school

This fall, some new students at private schools across the country will be children of parents who never considered or planned financially for anything other than public school. Whether they’re changing course because of concerns about learning loss, mental health or physical safety after three difficult years navigating the pandemic, the fact remains that an unexpected hit of many thousands of dollars a year can wreak havoc on a financial plan. Private school costs vary widely depending on location, school, and grade. Alison MacAlpine has more on discussions advisors can have with clients about private school.

Also see:

Building knowledge around RESPs is key to making higher education more affordable

Six health care stock picks to play defence in times of market volatility

How investors can help drive protection for biodiversity

What you and your clients need to know

Homeowners with mortgages to get short-term relief, but future Bank of Canada rate hikes a ‘looming’ fear

Borrowers will get some relief after the Bank of Canada kept its key interest rate steady Wednesday, but the housing market is not expected to rebound as quickly as it did in the spring, as the central bank left the door open to further rate hikes. In announcing that its benchmark interest rate would hold at 5 per cent, the bank said it continues to be concerned about inflation and is “prepared to increase the policy interest rate further if needed.” Rachelle Younglai has more.

Canadian bank CEOs warn of growing stress in U.S. operations as economic headwinds grow

The chief executives of some of Canada’s largest lenders are saying that mounting challenges in the U.S. banking sector are weighing on growth, in part by making it more expensive to do business in the U.S. market. The CEOs cited funding pressures and regulatory uncertainties they said are making it trickier to operate in an already sour economic environment. U.S. banks and Canadian lenders that operate in the U.S. are facing tougher competition for deposits. Stefanie Marotta explains.

More post-secondary students rely on parents, stay home to finish school, RBC poll shows

Inflation is driving more post-secondary students to stay home with their parents as they complete their studies – marking a shift from a decade ago, a poll published by Royal Bank of Canada on Wednesday shows. Almost half, or 47 per cent, of survey participants aged 18to 29 said they plan to live with their parents this school year compared with 36 per cent of students in 2013, the online survey reported. Ritika Dubey reports.

Charity funding is broken in Canada – business leaders must take note

CanadaHelps, which connects charities and donors, reported that two in 10 Canadians planned to access charitable services to meet essential needs in the next six months – a 14-per-cent increase from January 2022. Addressing these problems is more challenging than ever because the organizations that exist to provide help to vulnerable Canadians are in jeopardy. According to CanadaHelps, “giving participation” is declining among Canadians, and only 29.6 per cent of charities say they can meet the demand they are experiencing. Juanita Lee-Garcia provides more details.

– Globe Advisor Staff


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