Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 449

Size doesn’t matter when it comes to risk

I’d like to suggest to readers that there’s more risk in those global large cap allocations in your portfolios than you might think. And yes, I’m the portfolio manager of a global microcap Fund. I have a vested interest, but bear with me.

I’m not saying dump your large cap exposure, I’m simply advocating for a little more diversity than most investors currently have. Here’s why.

The end of the cycle?

Right now, there are various data points that suggest we are approaching the end of a significant market cycle. One I believe in has been extended by COVID-19. In the chart below, I have taken the decade-long run-up of the NASDAQ during the dotcom era and compared it to the run-up of the NASDAQ in the current growth cycle (calling a November 2021 cycle peak).

The run-up is almost identical, but for a global pandemic pushing the peak back 12 months.

Source: Bloomberg, Spheria

People say dotcom was different. They say it was ridiculous. But there’s been many a ridiculous phenomenon during this cycle – profitless tech on nose-bleed multiples, cryptocurrencies, SPACs, war-time-like fiscal stimulus, negative real interest rates.

Now, with many large cap tech names selling off materially in recent months, it appears 'risk off' (that is, reducing risk in portfolios) is back - an awakening perhaps for many investors who’ve been enthralled by an enduring period of easy money.

Many remain asleep to concentration risk

Concentration risk is often mentioned in Australian equities – “Too many Australian investors are overweight the big 4 banks, BHP and Telstra”. But less is spoken about the concentration risk investors are currently taking in global equities.

The impact of the proliferation of passive investing has been immense, with passive now around 55% of US equity funds. Throughout the 90s, it was 5%. In my view, there is no doubt that passive investments are the main conduit in which the tidal wave of Federal Reserve QE has entered the market. The result, as you can see below, is the most concentrated market in US history.

Source: Morningstar Direct, Spheria

Furthermore, in the funds management industry here in Australia, the concentration persists. Here I have compared three popular Australian actively-managed global equities funds. We see many crowded trades and much homogeneity.

Source: MSCI, Morningstar. As at 31 December 2021

Many of these companies are exceptional businesses but the perception that large caps are too large to fail must be challenged. Take a look at the S&P 500s Top 10 over time. It needs little explanation. History shows it’s not easy to stay at the top of the pile.

Source: S&P Dow Jones, Spheria

Where to invest as the cycle turns?

Checking some well-known recent market turning points, the table below shows at the dot-com peak, the market was overweight tech. At the GFC, it was financials.

Source: S&P Dow Jones

The question is what are investors overweight today as the cycle turns?

There’s strong historical evidence that allocating to stocks outside of the big end of town can strengthen portfolios at this time. The MSCI World Small Cap Index outperformed the larger MSCI World by 14% on the way down during the dot-com bust. While the MSCI World Microcap Index does not extend that far back, if the GFC and COVID are a guide, it would have outperformed by a similar magnitude.

Working with the available microcap data, the dot-com decline (below) shows the Wilshire US Microcap Index (the only microcap index at the time) outperformed both the NASDAQ and the S&P 500.

Source: Bloomberg, Spheria. NASDAQ Total Return Index unavailable during period examined. S&P and Wilshire Micro are Total Return Indices.

Microcaps were initially caught up in the risk-off before a plateau then a burst of strong outperformance as the global economy began to recover.

To highlight this further, below we have plotted the performance of global microcap relative to global large caps (dark blue line) against the 12-month change in US Purchasing Managers' Index (PMI), a measure of economic activity. In simple terms, as the economy accelerates, microcaps outperform and as the economy decelerates, microcaps underperform. While the asset class led markets out of the dotcom era, the GFC and COVID-19, there was only marginal underperformance on the way down.

Source: MSCI, Bloomberg, Spheria

This asymmetry during large market events provides investors a powerful asset allocation enhancement.

Demystifying global microcaps

Finally, global microcaps are a relatively underexplored and misunderstood asset class, being developed market securities with market caps of under US$1 billion (more akin to what we know as small cap Australian companies).

It’s the ‘little end of town’, you might say. But in this universe, there are over 18,000 securities globally and the US is only 24% of the index. And there are many misconceptions about this asset class, particularly when it comes to risk.

As bottom-up stock pickers, we believe investors are best served favouring growing and innovative businesses with strong cash flow conversion. In global microcaps, it’s a philosophy that enables a broad set of opportunity, and we also focus on capital preservation, with valuation discipline being a critical component in protecting capital.

A portfolio of global microcaps constructed against this disciplined framework of active management is why we don’t believe size matters, and how we believe investors can better navigate this current turning point in the market cycle.


Gino Rossi is Portfolio Manager at Spheria Asset Management, an affiliate manager of Pinnacle Investment Management. Pinnacle is a sponsor of Firstlinks. This article is for general information purposes only and does not consider any person’s objectives, financial situation or needs, and because of that, reliance should not be placed on this information as the basis for making an investment, financial or other decision.

For more articles and papers from Pinnacle Investment Management and affiliate managers, click here.



Hybrids alongside corporate bonds a good balance

Is your portfolio in need of rebalancing?

The 60/40 Portfolio – saying bye to old friends and welcoming new ones


Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates


The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.


Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.


The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.


The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.