The Case for Positive Earnings Criteria in International Small-Cap Benchmarks

We recently published a research paper, “Building Better International Small-Cap Benchmarks,” offering a comprehensive look at the recently launched S&P Global SmallCap Select Index Series. These indices are designed to measure the performance of small-cap companies with positive earnings.

Why incorporate positive earnings criteria into small-cap benchmarks? The initial foundation stems from two prior studies[1],[2]; the first study showed that the quality factor was one of the primary drivers of the return differential between two prominent small-cap benchmarks in the U.S. The second study found that the variability of the size effect mainly stemmed from the volatile performance of low-quality, or junk, small-cap firms. Additionally, the authors found that when junk or low quality is controlled for, the size premium becomes more robust in nature and can be found across industries, time periods, and 23 different markets.

Based on evidence found in the two papers, we investigated whether quality has earned a similar premium in international S&P DJI small-cap universes. To test the effectiveness of positive earnings, Exhibit 1 shows the average one-month excess return of positive earnings companies to negative earnings companies for each country in the S&P Global BMI universe.[3]

On average, profitable companies outperformed unprofitable companies in over 80% of the countries in the S&P Global BMI universe. In addition, we did not observe any geographical region bias, which leads us to conclude that excess returns being earned by profitable small-cap securities is potentially a global phenomenon. This is a key point in showing the robustness of this strategy, as the criteria shows consistent results across markets and regions.

Exhibit 2 shows that applying a positive earnings criteria to small-cap benchmarks has been an effective tool in attaining outperformance across multiple universes. For example, the S&P SmallCap Select Indices outperformed their S&P Global BMI counterparts across all regions, and the performance differential was particularly prominent in emerging markets.

As a result, incorporating a positive earnings screen can potentially be a useful way to boost returns across a number of markets, globally. To find out more about our recently launched S&P Global Small Cap Select Index Series, see the latest research paper.

[1] Brzenk, P. and A. Soe (2015). “A Tale of Two Benchmarks: Five Years Later.” S&P Dow Jones Indices.

[2] Asness, C., A. Frazzini, R. Israel, T. Moskowitz, and L. Pedersen (2018). “Size matters, if you control your junk.” Journal of Financial Economics. 129: 479-509.

[3] We limited the countries to those that had been in S&P Global BMI for the entire testing period. One-month returns are total returns (inclusive of dividends) in local currency.

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