Value Investing in International Small-Cap Equities: Navigating a Recovering Global Market with High-Conviction Opportunities

The global investment landscape in 2025 is marked by a confluence of macroeconomic shifts and market realignments, creating fertile ground for value investors targeting international small-cap equities. As central banks pivot toward accommodative monetary policies and global growth stabilizes, undervalued non-U.S. small-cap stocks are emerging as compelling opportunities. Pzena International's Small Cap Focused Value strategy, which targets the MSCI World ex USA Small Cap benchmark, exemplifies this trend, leveraging disciplined value investing to capitalize on market dislocationsInternational Small Cap Focused Value | IE | Pzena, [https://www.pzena.com/americas/institutional-investors/strategies/international-equities/international-small-cap-focused-value/]^[1].

Macroeconomic Tailwinds and Valuation Gaps

The recovery in global small-cap equities is underpinned by synchronized rate cuts and pro-business policies. The U.S. Federal Reserve's anticipated easing cycle, coupled with China's pivot toward its “new economy” sectors (e.g., electric vehicles and renewables), has reduced borrowing costs and spurred earnings growthMacroscope: 2025 Macro Outlook- Foundations of a global recovery, [https://ifamagazine.com/macroscope-2025-macro-outlook-foundations-of-a-global-recovery/]^[2]. Small-cap stocks, historically more sensitive to interest rate changes, are poised to outperform. For instance, the MSCI All Country World ex U.S. Small Cap Index trades at a forward P/E of 14.49, a 15% discount to Morningstar's fair value estimate, compared to large-cap valuations that remain inflatedThe case for international small-cap stocks - T. Rowe Price, [https://www.troweprice.com/financial-intermediary/us/en/insights/articles/2025/q3/the-case-for-international-small-cap-stocks.html]^[3].

This valuation gap is further amplified by structural trends such as reshoring, AI-driven demand for data centers, and electrification. Small-cap companies in sectors like regional banking (e.g., KeyCorp and Regions Financial) and industrial manufacturing (e.g., A. O. Smith Corporation) are particularly well-positioned to benefit from these shiftsUndervalued Darlings: Small-Cap and Value Stocks Outperform in Q3 2025 as Growth Stocks Hold Premium, [https://markets.financialcontent.com/stocks.lightwave/article/marketminute-2025-9-17-undervalued-darlings-small-cap-and-value-stocks-outperform-in-q3-2025-as-growth-stocks-hold-premium]^[4].

Pzena's Strategic Approach: Discipline in Volatility

Pzena's Q2 2025 commentary underscores the firm's commitment to value investing amid heightened volatility. Trade-war fears and geopolitical tensions in the Middle East, while disruptive in the short term, have historically created buying opportunities for disciplined investors. The firm notes that value stocks tend to outperform in the five years following extreme volatility, a pattern observed during the 2020 market crashSecond Quarter 2025 Commentary | Insights | Pzena, [https://www.pzena.com/americas/institutional-investors/insights/how-downturns-create-long-term-opportunity-2q-2025/]^[5].

The Pzena International Small Cap Value Fund (PZVIX), with a 1.45% expense ratio, has delivered 20.32% year-to-date returns as of September 2025, supported by a Sharpe ratio of 1.07 and a Sortino ratio of 1.45Pzena International Small Cap Value Fund (PZVIX) - Stock Analysis, [https://portfolioslab.com/symbol/PZVIX]^[6]. While the fund's worst drawdown (56.16% in March 2020) highlights its risk profile, its recovery trajectory underscores the resilience of value-oriented strategies in cyclical markets.

Sector Opportunities and High-Conviction Picks

Reputable sources highlight specific sectors where international small-cap equities are undervalued:
1. Regional Banking: Firms like KeyCorp (KEY) and Regions Financial (RF) benefit from lower interest rates and improved credit demand33 Undervalued Stocks to Buy in Q3 2025 - Morningstar, [https://www.morningstar.com/stocks/33-undervalued-stocks-2]^[7].
2. Industrial Components: A. O. Smith Corporation (AOS) is gaining traction in energy-efficient manufacturing33 Undervalued Stocks to Buy in Q3 2025 - Morningstar, [https://www.morningstar.com/stocks/33-undervalued-stocks-2]^[7].
3. Energy and Electrification: Copper-related sectors and renewable energy infrastructure are attracting capital as global electricity demand surgesMacroscope: 2025 Macro Outlook- Foundations of a global recovery, [https://ifamagazine.com/macroscope-2025-macro-outlook-foundations-of-a-global-recovery/]^[2].

Morningstar's Q3 2025 analysis further identifies non-U.S. small-cap opportunities in the basic materials and communication services sectors, where over half of telecom subsector stocks are rated 4–5 stars33 Undervalued Stocks to Buy in Q3 2025, [https://www.morningstar.com/stocks/33-undervalued-stocks-2]^[8].

Risks and Considerations

While the case for international small-cap value investing is strong, investors must remain cognizant of risks. The Pzena fund's high expense ratio and historical volatility (e.g., a 56.16% drawdown in 2020) necessitate a long-term horizon. Additionally, U.S. tariffs and geopolitical uncertainties could temporarily disrupt marketsThe case for international small-cap stocks - T. Rowe Price, [https://www.troweprice.com/financial-intermediary/us/en/insights/articles/2025/q3/the-case-for-international-small-cap-stocks.html]^[3]. However, the anticipated Fed rate cuts and global economic normalization provide a counterbalance.

Conclusion

The interplay of macroeconomic recovery, valuation discounts, and sector-specific tailwinds positions international small-cap equities as a cornerstone of value investing in 2025. Pzena's disciplined approach, combined with broader market trends, offers a roadmap for capturing long-term growth. For investors willing to navigate short-term volatility, the current environment presents a rare alignment of opportunity and value.