Diversification Benefits of European Small-Cap Stocks after the Global Financial Crisis and Brexit

Abstract

In this article, we investigate the diversification gains obtained from investing in European small-cap stocks, focusing on the periods since the Global Financial Crisis and Brexit. We find mixed evidence to support the assertion that European small-caps provide diversification benefits to a benchmark portfolio of large US stocks. The benefits are also limited when benchmark assets include both a US large-cap portfolio as well as a portfolio of European large-cap stocks. After Brexit, US investors achieve diversification benefits from investments in European large-cap stocks. However, after Brexit, small-cap stocks from only one country in the European Union are shown to offer additional diversification gains.

TOPICS: Legal/regulatory/public policy, financial crises and financial market history, portfolio management/multi-asset allocation, portfolio theory, portfolio construction

Key Findings

• • In the aftermath of the Global Financial Crisis, from a US investor’s perspective, the benefits of investing in European Small-Caps have declined.

• • Since the UK vote affirming Brexit, with the exception of one country, European Small-Caps have become even less attractive for US investors.

• • Brexit has not nullified diversification benefits for Large-Cap European stocks with significant international exposure.