Harnessing Active Multi-Manager Strategies to Navigate Volatility in International Small-Cap Markets

The international small-cap market has long been a double-edged sword for investors: a source of outsized returns in favorable cycles and a crucible of volatility in times of macroeconomic stress. In mid-2025, this duality is amplified by a confluence of forces—trade policy uncertainty, benchmark distortions, and shifting global growth dynamics. Yet, amid the turbulence, a compelling case emerges for active multi-manager strategies, which can exploit mispriced growth opportunities while mitigating the risks inherent in a fragmented and speculative landscape.

The Macroeconomic Crosscurrents

The global economy is navigating a period of structural recalibration. Trade policy shifts, particularly in the U.S., have introduced a drag on global growth, with tariffs acting as a de facto tax on businesses and households. J.P. Morgan Research estimates that these policies could reduce U.S. household purchasing power by 1.5% and depress business investment by 2% annually. For international small-cap companies, which often lack the scale to absorb such shocks, the implications are stark. Emerging market (EM) growth, already slowing to 2.4% in the second half of 2025, faces further headwinds as trade tensions and energy market volatility amplify inflationary pressures.

Meanwhile, the fading of U.S. exceptionalism—a period of relative economic outperformance—has created a vacuum in global capital flows. The U.S. dollar, once a safe haven, is now bearish, with EM currencies projected to outperform. This shift is both a tailwind and a risk: weaker local currencies can boost consumption and investment in EM small-cap markets but also expose them to capital outflows during periods of dollar strength.

Benchmark Distortions and the Rise of Passive Flows

The most insidious challenge for small-cap investors lies not in macroeconomic volatility but in the structural distortions of benchmarks. Passive investing, which allocates capital based on index rules rather than fundamentals, has flooded small-cap indices with capital, often favoring perma-small companies over high-quality growth opportunities. The Russell 2000, for instance, includes firms with stagnant revenue and weak balance sheets alongside innovators, diluting the index's appeal.

This lack of quality control has led to a mispricing of risk. High-quality small-cap stocks, which historically outperformed large-cap peers by 3-5% annually, now trade at significant discounts. For example, the SMIDG composite—a benchmark for actively managed small-cap growth—outperformed the Russell 2500 Growth Index by 1.74% in Q2 2025, driven by exposure to sectors like industrials and communications services. Passive strategies, by contrast, remain overexposed to speculative plays and underexposed to durable growth opportunities.

The Case for Active Multi-Manager Strategies

Active multi-manager strategies offer a solution to this paradox. By aggregating the expertise of multiple managers, these strategies can:
1. Identify mispriced opportunities: Active managers can screen for companies with strong returns on capital, sustainable competitive advantages, and exposure to long-term trends like AI-driven infrastructure or onshoring.
2. Diversify risk: A multi-manager approach allows for geographic and sectoral diversification, reducing overexposure to volatile EM markets or cyclical sectors.
3. Adapt to macroeconomic shifts: Managers can dynamically adjust portfolios in response to trade policy changes, currency fluctuations, or geopolitical risks.

Consider the case of a multi-manager fund that overweighted EM small-cap industrials in 2025. As onshoring trends gained momentum, these firms—often overlooked by passive benchmarks—delivered double-digit returns, outperforming their large-cap counterparts by 8%. Conversely, the same fund avoided overexposure to EM consumer discretionary stocks, which underperformed due to pricing pressures.

Navigating the Volatility

To capitalize on these opportunities, investors must adopt a disciplined approach:
- Focus on quality: Prioritize companies with strong balance sheets, recurring revenue models, and defensible moats.
- Leverage thematic insights: Align portfolios with structural trends, such as energy transition or digital transformation, which are likely to drive growth in small-cap markets.
- Monitor macroeconomic signals: Track EM central bank rate cuts, U.S. trade policy developments, and currency movements to adjust allocations proactively.

Conclusion

The volatility in international small-cap markets is not a barrier but a catalyst for active investors. By embracing multi-manager strategies, investors can navigate benchmark distortions, exploit mispriced growth opportunities, and build resilient portfolios in an era of macroeconomic uncertainty. The key lies in combining rigorous fundamental analysis with strategic agility—a formula that has historically delivered superior risk-adjusted returns and remains as relevant as ever in 2025.

For those willing to look beyond the noise of passive benchmarks, the small-cap universe offers a treasure trove of value waiting to be unlocked.