Looking Under The Hood Of Recent Global Small- And Large-Cap Performance

By Mark Barnes, PhD & Indhu Raghavan, CFA

The relative performances of large-cap equities to small-caps in developed and emerging regions have tracked one another for the better part of the last decade. However, around early-2021 they began to diverge. Since then, developed large-caps have outperformed their small-cap counterparts, while in the emerging region, large-caps steeply underperformed small-caps (Exhibit 1).

Exhibit 1: Large-Cap/Small-Cap Relative Return, Developed And Emerging (Rebased, USD)

What caused this divergence in large-cap/small-cap relative performance in the two regions? Exhibit 2a shows the total return of the four underlying indices (FTSE Developed Large Cap Index, FTSE Developed Small Cap Index, FTSE Emerging Large Cap Index and the FTSE Emerging Small Cap Index) for the 38 months prior to the start of the performance divergence (“earlier period”), and Exhibit 2b for the 38 months since the beginning of the performance divergence (“later period”).

In the earlier period, spanning November 2017 to December 2020, the two large-cap indices generally outperformed their small-cap counterparts. What shifted notably in the later period, spanning January 2021 to February 2024, is the performance of the emerging large-cap index, which posted steep losses and underperformed the other cohorts, while the emerging small-cap index’s performance was in line with its developed market counterpart. One hypothesis is that there was a broad-based pullback among large-cap equities across the emerging region.

Exhibit 2A: Cumulative Return, Earlier Period (Rebased, USD)

Exhibit 2B: Cumulative Return Across The FTSE Developed Large Cap Index, FTSE Developed Small Cap Index, FTSE Emerging Large Cap Index And The FTSE Emerging Small Cap Index, Later Period (Rebased, USD)

To understand what is driving this performance gap we looked at the country contribution to returns of the two emerging indices.

Exhibit 3a shows the country contributions to total return for the Emerging Large-Cap Index. China, Taiwan and India dominated contributions, with China contributing 16 percentage points of the index’s 26.9% return in the earlier period, and India and Taiwan rounding out the rest. (modest contributions and detractions from other constituent countries netted to zero.) In the later period, China detracted by 22.7 percentage points from index returns, which was only partly offset by India’s and Taiwan’s positive contribution.

These three countries’ influence on index returns was not surprising given they were the three largest countries by index weight in both emerging indices at the beginning of both periods. They constituted between half and two-thirds of the index by weight.

Exhibit 3A: Contributions To FTSE Emerging Large Cap Index Total Return, By Country (USD)

Exhibit 3b shows country contributions to total return for the FTSE Emerging Small Cap Index. While Chinese small-caps’ contributions also reversed between the earlier and later periods, there was a substantial increase in the contribution from Indian small-caps in the later period which offset the drag in performance from China.

Exhibit 3B: Contributions To FTSE Emerging Small Cap Index Total Return, By Country (USD)

In another level of disaggregation, we examined the total returns and starting weights for each of these large country constituents. Exhibits 4a and 4b show total returns by country for the emerging large-cap and small-cap indices. Exhibits 5a and 5b show starting and ending weights for the emerging large-cap and small-cap indices for the two periods under consideration. Two points are worth noting.

First, Chinese equities’ underperformance in the later period was comparable in the large-cap and small-cap space, -47.5% versus -43.5% respectively. Clearly, their starting weights in their respective indices, 46.8% versus 25.2%, mattered for their impact on overall index return (detracting by -22.7% vs. -11.5% respectively).

Exhibit 4A: Total Returns In The FTSE Emerging Large-Cap Index (USD)

Exhibit 4B: Total Returns In The FTSE Emerging Small-Cap Index (USD)

Second, for the later period, India’s starting weight in the small-cap and large-cap indices was comparable at 13.1% vs 10.9% respectively. However, Indian small-caps substantially outperformed Indian large-caps (84.6% vs 52.3%) to make a relatively larger contribution to the small-cap index’s return (12.6% vs 6.2%).

Exhibit 5A: Starting And Ending Weights In The FTSE Emerging Large-Cap Index

Exhibit 5B: Starting And Ending Weights In The FTSE Emerging Small-Cap Index

Conclusion

The emerging large-caps index’s total return alone seemed to suggest that there may have been a broad-based pullback in large-cap performance in the later period. However, upon closer examination of index composition and country-level performance, the sharp shift in its fortunes during the later period seems to be largely explained by country-specific factors.

This exercise highlights the importance of examining country (and, where relevant, industry) level data to understand the drivers of index performance, which may be due to the composition of the index or genuine performance differences across regions and time periods, or both.

Further, the evolution and composition of indices provide a starting point for thinking about the potential drivers of index performance in the future.

The FTSE Russell indices mentioned in this insight were FTSE Developed Large Cap Index, FTSE Developed Small Cap Index, FTSE Emerging Large Cap Index and FTSE Emerging Small Cap Index. All performance numbers are in USD.

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