Investment Spotlight: DFA International Small Company and Small Company Value

Portfolio weight: varies from ~3-14% of typical client portfolios

International small companies have been stellar performers over the past few years.  A combination of low interest rates, increasing economic growth, and political reform in many countries has brightened the future.  The globalization of capital markets and increased risk appetite has enhanced the opportunities for small companies around the world to raise capital while improvement in communications technology has enabled them to compete in markets far from home (the world really is flat).  Nevertheless, this sector suffered its share of revaluation in the recent correction in equity markets.  Still, we remain convinced that this area merits the long term return expectations we have for it and, thus, considerable allocation in our clients’ portfolios.

An important aspect of our conviction is the portfolio construction benefit of including small companies.  The economic and market forces affecting small companies are different from those facing larger companies.  The result is a return and risk profile somewhat different from their larger competitors, which shows up as a lower correlation in our capital market expectations.  The diversification provided by investing in both large and small companies allows clients to build portfolios with a higher expected (and, over the past six years, realized!) return without increasing total portfolio risk.

To gain exposure to small companies in developed markets overseas, we currently use two funds from Dimensional Fund Advisors: the International Small Company fund (DFISX) and the International Small Cap Value fund (DISVX).  The funds have $3.8 billion and $5.4 billion, respectively, invested in the small companies in Europe, Japan, Asia Pacific, and the United Kingdom.  As of May 31, the approximate regional allocation for both funds was as indicated in the graph below:

The funds currently invest in companies in Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and United Kingdom.

To mitigate the risk of owning small companies (median market cap of $236 million, with the largest at a market cap of about $5 billion), the funds are very broadly diversified, holding about 4,300 different issues.  Currency risk is not directly hedged, though the geographic spread of the investments provides some risk mitigation (see the article in this Commentary on currency impacts).

Selected Investments
The following investments are representative of holdings in DFISX and DISVX:

The Regus Group, based in London, has a network of 750 business centers located at many of the most prestigious office buildings in 60 countries around the world.  The company's business centers offer a mix of workstations, conference rooms, and support services, such as video conferencing, telecommunications, internet connectivity, reception and secretarial services.  The Regus Group is the world's largest independent provider of video-conferencing facilities and a leader in the provision of meeting rooms in a professional office environment.  In 2005, the Regus Group generated profit from operations of £45 ($25) million on revenue of £463 ($252) million.

Qiagen, based in Germany, is the leading provider of innovative technologies and products for the biotechnology industry. Qiagen has more than 500 proprietary, consumable products and automated solutions for biotech laboratories.  In 2005, Qiagen generated net income of $62 million on sales of $398 million.

Body Shop International Plc develops and sells skin and hair care products and related items through its shops, franchised outlets, home sales, mail order catalogues and the Internet. In 2005, Body Shop generated net income of £27 ($15) million on revenue of £709 ($386) million.

Ryobi, based in Japan, manufactures die-casting products, printing equipment, power tools and builders' hardware.  For the fiscal year ending 3/31/06, Ryobi expects net income of ¥6.5 to ¥8.5 billion ($56 – 74 million) on sales of ¥158 ($1.4) to ¥171 ($1.5) billion.

Jason Thomas, PhD,
Chief Investment Officer

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