Small caps do not typically export their products, but many still import raw materials and other goods from outside Europe as part of their production process. Unlike exports, imported goods become cheaper as the domestic currency appreciates against others, leading to an increase in purchasing power, which ultimately increases profitability by lowering costs.
Looking to Small Caps for Higher Beta
Another benefit—if one believes Europe is recovering—is that small caps are more sensitive to trends in the economy because of their cyclical exposure. In other words, small caps often have higher beta—or market reactions—to both the ups and downs in the markets.
These trends can be seen in the year-to-date performance of large-cap versus small-cap stocks and indexes.
In the chart below we examine the year-to-date returns of the 10 largest index constituents of the FTSE Developed Europe Index (FTSE Europe), used to represent large-cap equities. For comparison purposes we also chart the WisdomTree Europe SmallCap Dividend Index (WTESC) to represent European small-cap equities.
Year-to-Date Performance
For current performance of the WisdomTree Europe SmallCap Dividend Index, please click here.
• Small Caps Have Outperformed Large Caps – Collectively, WTESC has outperformed FTSE Europe by 16%, but the return advantage is even more impressive when comparing individual large-cap stocks. WTESC has been able to outperform 8 out of 10 of the largest holdings and has more than doubled the returns of half of the stocks. Obviously there are differences in risks between an individual security and an index, but we still find it important to note that some of the largest-capitalization stocks in Europe have underperformed a diversified basket of small caps by so much.