The amount of research on the persistence of investment manager outperformance among global small-cap managers is limited simply because it is a new asset class in most fund classification systems. Soe and Dash (2009) investigated top-quartile investment managers in the Lipper International (developed world ex-US) small-cap universe. Figure 6 shows the results of the analysis of rolling three-year annualised investment performance. On average, only 23 per cent of topquartile investment managers can repeat their top-quartile performance from the previous three years over the next three-year horizon. The research considered above indicates that it is difficult for active investment managers investing in small-caps to consistently outperform the benchmark over several years. At the same time it also indicates that it is possible for a small majority of skilled and experienced global smallcap investment managers to outperform. Thus it is up to the reader to decide whether the glass is half-empty or half-full.

Is passive investment a good idea for global small caps ? The breadth of the global small-cap investment universe makes it difficult to construct a passive portfolio that fully captures the global small cap investment opportunity. There are three reasons for this: 1. In terms of size, the global small-cap investment universe triples the global large- and mid-cap investment universe. This means that a full-replication passive strategy for global small-caps would potentially have to hold between 6,500 and 7,000 shares. 2. A passive investment strategy invests in shares regardless of their valuation, quality, earnings and future prospects. Analysis by GMO of the period from December 1974 to December 2000 shows that on average, smaller companies had lower earnings growth rates and a lower return on equity relative to larger companies. This presents an opportunity for skilled, experienced active investment managers to outperform if they can successfully sort the wheat from the chaff. 3. The breadth of the smallcap investment universe means that there are more shares which have similar market capitalisation relative to the large- and mid-cap investment universe where much of the market capitalisation is concentrated is a small number of shares. Consequently, even the most simple passive portfolio needs to hold at least 1,000 shares in the MSCI ACWI Small Cap Index (about 15.4 per cent of the benchmark) to capture about 50 per cent of the index market capitalisation. By contrast, 50 per cent coverage of the MSCI ACWI Standard Index, which has around 2,400 shares, can be accomplished by a passive portfolio of only the top 200 shares (about 8.3 per cent of the benchmark).