Sustainable small caps. A combination with potential.

Investments in small-cap equities offer attractive return opportunities over the long term thanks to the risk premium. Adding an ESG¹ filter can reduce the risks associated with the asset class. No wonder, that small caps have evolved into an important pillar of asset allocation. Read on to find out why small caps could also be a good fit for your portfolio.

April 20, 2021

Small caps have posted an impressive performance in recent years. Just ten years ago, there was still limited demand on the part of Swiss investors for small-cap exposure. Above all, this was due to their low market volume and weak trading activity. Fast forward to today, however, many investors consider this asset class to be an important pillar of strategic asset allocation. This is evidenced by the growth in assets under management in our Credit Suisse Index Funds (CSIFs) (see Chart 1). Since the first CSIF Small Cap was launched in 2013, assets under management have seen a steady rise to over CHF 3.5 billion. What is the reason for the growing interest in small caps?

Chart 1: Asset growth of Credit Suisse Index Funds Small Cap

Source: Credit Suisse. Data as of December 31, 2020.

To begin with, the share of small caps in total market capitalization has long been underestimated. However, a closer examination of the equity market over the years shows that the share of small caps has long exceeded 12% and is therefore almost as high as that of mid caps (see Chart 2) or on a par with the share of emerging markets in the MSCI All Country World Index.² It therefore makes sense not only to focus on broad-based investments in large and mid caps, but also to give appropriate consideration to small caps.

Chart 2: Market capitalization of MSCI World Investable Market Index (IMI)

Sources: MSCI, Credit Suisse. Data as of December 31, 2020.

Three reasons to invest in small caps

In addition, empirical results show that – thanks to a well-documented small-cap premium – small caps generate an additional return versus mid and large caps over the long run³ (see Chart 3). Small caps have consistently gained ground on mid and large caps since the 2008/2009 financial crisis.

Last but not least, incorporating small caps broadens a portfolio’s diversification by 4,303 additional stocks⁴ and thus minimizes the idiosyncratic (or unsystematic) risk.

Chart 3: Performance of MSCI World Small Cap Index vs. MSCI World Index 

Sources: MSCI, Bloomberg, Credit Suisse as of 31.12.2020. Data interval: June 2001 to December 2020, monthly gross returns in Swiss francs.

Small caps and ESG: a combination that creates added value

For chiefly structural reasons, the small-cap segment is exposed to higher risks than large or mid caps. The business processes of small companies tend to be less stable and less scalable. In addition, risks are often neglected due to a strategy focused on growth. This structural disadvantage is readily discernible in the ESG rating distributions and average ESG ratings: The MSCI World Small Cap Index had an ESG score of 5.1 (equivalent to a rating of BBB) as of December 31, 2020. The MSCI World Index, on the other hand, achieved a score of 6.1 (equivalent to a rating of A) (see Chart 4).

Chart 4: ESG rating for small and large caps  

Source: MSCI as of 31.12.2020.

For most of our sustainable equity funds, we use the firmly established ESG Leaders approach from index provider MSCI. The broadly diversified indices cover all regions and exhibit risk/return profiles that are comparable to their parent indices. This is mainly due to the two-stage method: In a first step, companies with significant income from controversial activities or business practices (e.g. arms trading) are systematically excluded. The remaining companies are subject to a detailed analysis based on publicly available data. This analysis results in the MSCI ESG rating. In a second step, a so-called best-in-class approach is applied, where the top 50% of companies in terms of ESG rating are included in the ESG Leaders Index. In the case of small caps, around 25% are excluded in the first step based on their market capitalization. By comparison, this figure is just 10% for mid and large caps (see Figure 1).

Figure 1: Application of the MSCI ESG Leaders methodology: large and mid caps vs. small caps


Key features of MSCI ESG Leaders indices vs. standard index

When rating small caps, why doso many companies get excluded already in the first step? One frequently cited argument is insufficient or incomplete data. This is only partly true. When external rating companies such as MSCI are unable to find data on certain ESG topics (because smaller firms are less transparent) this can lead to gaps in the overall picture and thus to a lower overall rating. Therefore, in certain situations, smaller firms are not covered by data providers at all. However, the ESG data gathered by MSCI has grown to cover almost 95%. The greatest challenge remains Japan, where around 25% of data are still missing, although the scope of coverage is increasing here too. Accordingly, most companies do not fail to make the grade due to insufficient data, but rather primarily because they do not rank in the top half of ESG performers or because their ratings are too low. What is more, many specialized small caps are active in controversial business areas and are therefore excluded from sustainable strategies more frequently than larger companies

The approach taken by MSCI therefore creates a robust Small Cap ESG Leaders Index that serves as a basis for our new CSIF: CSIF (CH) Equity World ex CH Small Cap ESG Blue.

Index Solutions

Credit Suisse Index Funds, or CSIF for short, has stood for precision, daily liquidity, and minimized investment costs since 1994.

MSCI World Small Cap ESG Leaders Index: attractive return and low tracking error

Applying the MSCI ESG Leaders methodology likewise results in a lower tracking error for the MSCI World Small Cap ESG Leaders Index against the standard index (see Chart 5). Comparing the performance of the two indices additionally reveals that the return has developed practically in the same way with a comparable exposure to risk. The slight underperformance over the past two years is mainly due to the exclusion of certain biotech firms with very good results in the final months of last year.

Chart 5: Performance of MSCI World Small Cap ESG Leaders Index vs. MSCI World Small Cap Index 

Sources: MSCI, Bloomberg, Credit Suisse. Data interval: November 2018 to December 2020, monthly gross returns in Swiss francs.

Replicating small cap indices: a technical challenge we mastered for over ten years

Small cap indices are characterized by their high number of stocks with even distribution in terms of weighting. For this reason, it is important to preserve this uniformity when buying and selling stocks in order to replicate the benchmark as closely as possible. The empirically based tracking error figure can be a good indicator of a portfolio’s ability to replicate the index. Given the large number of stocks in the index, however, the sum of all idiosyncratic risks (the sum of all individual deviations) can present a not inconsiderable risk.

Idiosyncratic risk using the example of Gamestop⁵

ESG investing

More interesting insights about sustainable investing are just one click away.

In this area as well, investors can benefit from the long-standing experience of the experts at Credit Suisse Index Solutions. Our tracking-error-based optimization approach, which takes into account idiosyncratic risks as well as sometimes reduced liquidity, extremely low trading costs, an in-house execution desk, and dedicated corporate action handling are just some of the benefits we offer to ensure perfect index replication.


A new fund to complement our product range

The CSIF (CH) Equity World ex CH Small Cap ESG Blue replicates the MSCI World ex CH Small Cap ESG Leaders Index. With this fund, investors save on tax because it invests 20% in our CSIF (IE) MSCI USA Small Cap ESG Leaders Blue UCITS ETF, and Irish ETFs pay withholding tax of just 15% instead of 30% on US dividends compared with index funds.

If you would like to benefit from the advantages that are offered by small caps and are considering incorporating them, our index funds can help you minimize risks such as sharp price fluctuations. With the launch of the new index fund, we are taking another targeted step to expand and complement our ESG product offering. This will grow our ESG range to a total of 24 funds and further solidify our position as a leading provider of sustainable index funds in Switzerland.6

Coming soon


General risks of index funds

  • The funds do not offer capital protection. Investors may lose some or all of the capital they invest.
  • The funds’ investments are subject to market fluctuations.
  • The funds do not significantly outperform their benchmark indices.
  • Shares are subject to market, sector, and company-specific risks that may result in price fluctuations.

The product’s investment objectives, risks, charges, and expenses, as well as more complete information about the product are provided in the prospectus (or relevant offering document) which should be read carefully before investing.


Dimitri Bellas

Head of Client Portfolio Management Multinational & Romandie and ESG Expert

Oliver Ferrari

Head of Emerging Markets & Small Caps Index Solutions

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1 ESG stands for environmental, social, and governance. The term has also established itself in the financial sector as the basis for assessing how sustainable an investment is.
2 Share of emerging markets in MSCI All Country World Index: 13.5% as of 31.12.2020. 
3 E.g.: Fama and French (1993), Lakonishok, Shleifer, and Vishny (1994), Dichev (1998), Vassalou and Xing (2004), Liu (2006), Zhang (2006).
4 Investment universe of MSCI World IMI Index as of 31.12.2020. 
5 The securities mentioned on this page are meant for illustration purposes only and are not intended as a solicitation or an offer to buy or sell these securities.
6 Source: Morningstar as of 30.01.2021. 

Past performance and financial market scenarios are not reliable indicators of future performance. 

Source: Credit Suisse, if not indicated otherwise.
Unless explicitly stated otherwise, all figures in this document were compiled by Credit Suisse Group AG and/or its affiliates with the greatest of care and to the best of its knowledge and belief.
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