In a market dominated by U.S. mega-cap tech and elevated valuations, many investors may be overlooking one of today’s most compelling long-term opportunities: emerging markets small-cap equities. At Kayne Anderson Rudnick, we believe this segment provides access to high-quality businesses operating in fast-growing economies while also benefiting from structural inefficiencies that can create outsized return potential.
In this Q&A, Portfolio Manager and Senior Research Analyst Hyung Kim explains why investing in emerging markets—particularly through small-cap equities can provide portfolio diversification, alpha potential, and sustainable long-term growth for investors seeking to move beyond traditional large-cap allocations.
What Makes Emerging Markets Small Caps Attractive for Long-Term Investors?
Emerging markets small-cap equities are gaining renewed attention and for good reason. In Hyung’s view, three structural advantages make this asset class particularly attractive:
- Faster economic growth in developing countries creates strong tailwinds for small businesses
- Market inefficiencies that may allow skilled investors to identify undervalued small-cap equities
- Significant portfolio diversification benefits, especially as U.S. large caps become more correlated and mature
Together, these features create a fertile landscape for investing in emerging markets small caps and may give investors long-term upside potential.
Why Have Emerging Markets Small Caps Underperformed in the Past Decade?
Despite recent underperformance, it’s essential to view emerging markets small-cap equities within a longer-term context. From 2000 to 2010, emerging markets outpaced the S&P 500. While the following decade (2010–2020) saw U.S. large caps outperform, a broader view reveals that emerging markets small caps have kept pace with major benchmarks like the S&P 500 and Russell 2000 across cycles. In fact, there have been multiple periods where U.S. equities lagged behind emerging markets. Hyung believes investors should be cautious of recency bias when evaluating this asset class.
Hyung points to three main drivers behind recent underperformance:
- China’s policy and geopolitical uncertainty
- A strong U.S. dollar, which has been a headwind for investing in emerging markets
- Valuation compression, reducing investor sentiment toward non-U.S. small-cap equities
However, these challenges may be easing, making it a timely moment to reconsider this segment for strategic portfolio diversification.
Why Is Now a Strategic Time to Invest Globally?
Hyung sees this moment as a compelling opportunity to invest globally, especially in emerging markets small-cap companies that are:
- Well-managed, with sustainable competitive advantages
- Trading at attractive valuations
- Positioned for durable earnings growth over time
In addition to these fundamentals, investing in emerging markets may offer much-needed portfolio diversification, reducing overexposure to a concentrated and overvalued U.S. equity market. For long-term investors, this could expand global equity exposure.
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