Raising The Bar In Canadian Small Caps
Prior research has demonstrated that profitability matters for small-cap companies in the U.S. and in global equity markets. For example, the S&P SmallCap 600®—which includes an earnings eligibility criteria—has outperformed the broader Russell 2000 Index (with lower volatility) over its 25-year track record.
Our new S&P/TSX SmallCap Select Index extends this phenomenon to Canadian equities, where we have found that a similar effect exists. Simply put, filtering out the “junk” makes a big difference in Canadian small caps. Exhibit 1 illustrates the total return improvement and volatility reduction of the S&P/TSX SmallCap Select Index versus the broader S&P/TSX SmallCap Index over the past 15 years.
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How Does the S&P/TSX SmallCap Select Index work?
The index follows the same methodology framework as our existing S&P SmallCap Select Index Series but uses the S&P/TSX SmallCap Index as its selection universe. In order to be eligible for index inclusion, companies must post two consecutive years of positive earnings per share. As a buffer, companies are dropped from the index after posting two consecutive years of negative earnings. In order to improve replicability of the index, we also eliminate the 20% smallest and 20% least liquid companies. The index is weighted by float market cap and is rebalanced semiannually in June and December.
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As of the June 2019 index rebalancing, the S&P/TSX SmallCap Select Index included 100 of the 199 companies in the S&P/TSX SmallCap Index and captured about 65% of the float market cap of the benchmark index. As shown in Exhibit 3, the majority of the exclusions were driven by the positive earnings requirement.
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To learn more about the impact of including a positive earnings requirement in Canadian small caps, please see our recently published more