The Shifting Small Cap Premium: Smallest of the Small or Smallest of the Big?
Christopher Meeske, CIMA® & Ashvin Viswanathan, CFA
■ The higher returns earned by smaller securities—the “small-cap premium” or “Size factor”—have been documented and studied for decades, with data stretching back almost a century showing that stocks with higher market capitalizations underperform smaller stocks.
■ However, in recent decades the size premium has become less significant as classically measured, and there have been a number of periods of time where the Size factor was negative.
■ In this paper, we look at the changes to the small-cap premium, the relative reliability of the higher returns of the smallest capitalization stocks relative to other market segments, and the nature of small-cap investing across many periods.
■ Additionally, we look at the sensitivity of smaller-capitalization securities to profitability—another quantitative factor which has a disproportionate impact on small-cap stock returns.
The Size factor—the premium in returns earned by smaller capitalization stocks over the long term when compared to larger companies—is a well-studied and long-standing phenomenon. Described at least as early as 1981 by Rolf Banz in “The Relationship Between Return and Market Value of Common Stocks,” the higher returns earned by small-cap stocks are traditionally explained in terms of risk, with larger companies representing safer investments which cannot command as high an expected return.