Image Source:
As the celebrates its fifth anniversary, it’s an opportune time to reflect on the index’s performance, construction and composition compared to the benchmark S&P/TSX SmallCap Index. With a five-year live track record, the select index has demonstrated its ability to measure the Canadian small-cap segment with higher total returns and lower volatility.
Understanding the S&P/TSX SmallCap Select Index
The S&P/TSX SmallCap Select Index employs the same methodological framework as our existing , but it utilizes the S&P/TSX SmallCap Index as its selection universe. To qualify for inclusion, companies must achieve two consecutive years of positive earnings per share. As a safeguard, companies that report two consecutive years of negative earnings are removed from the index. To enhance replicability, we also exclude the smallest 20% and the least liquid 20% of companies. The index is weighted by float market capitalization and is rebalanced semiannually in June and December.(Click on image to enlarge)
As of Oct. 31, 2024, the S&P/TSX SmallCap Select Index included 135 of 243 S&P/TSX SmallCap Index constituents, representing 66% coverage by index weight. As illustrated in Exhibit 2, the S&P/TSX SmallCap Select Index showed a higher average median daily value traded (MDVT), representing enhanced liquidity. By focusing on a smaller subset, the select index eliminates less actively traded stocks. This targeted approach emphasizes securities with higher turnover and size, potentially translating to increased capacity and replicability compared to the benchmark index.(Click on image to enlarge)
Long-Term Track Record of Outperformance
Over the past twenty years, the S&P/TSX SmallCap Select Index outperformed the benchmark S&P/TSX SmallCap Index by approximately 2% per year with lower volatility. The S&P/TSX SmallCap Select Index rebounded more quickly during periods of extreme volatility compared to its benchmark, possibly thanks to its emphasis on liquidity and financial stability. This trend is particularly evident during times of market stress, such as the COVID-19 pandemic and its aftermath, when smaller, less liquid companies typically faced larger losses than their more stable peers.(Click on image to enlarge)
The S&P/TSX SmallCap Select Index has outperformed the benchmark during several periods, as shown in Exhibit 4. The index also experienced lower volatility, as reflected by its lower standard deviation, indicating more consistent returns and reduced exposure to the sharper price fluctuations that were seen in the broader S&P/TSX SmallCap Index.
The S&P/TSX SmallCap Select Index has shown strong performance relative to the benchmark, with a hit rate of 69.2% during down months, suggesting its resilience in volatile markets. The lower down-market capture ratio indicates that the index was less affected by the market’s downside, providing additional stability during the market decline.(Click on image to enlarge)
In conclusion, the S&P/TSX SmallCap Select Index demonstrates that a more targeted approach that excludes companies deemed less profitable along with the smallest and least liquid securities has historically improved long-term total returns, reduced risk and enhanced liquidity compared to the broader Canadian small-cap segment.More By This Author:
Profitability Matters In Canadian Small Caps
