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Small Cap Investing and the Size Premium

  • ,  Chief Executive |
  • 25 Jul 2018
  • Updated 27 Sep 2018

Does Market Capitalization Matter?

It would certainly seem so, as the Russell 2000 has outperformed the Russell 1000 by around 5% so far this year (up 11% vs 6% as of 23/7/18).  With this in mind we turn a keen eye to papers on small-cap equities. 

The size premium is a factor anomaly that has been discussed in a variety of academic papers.  Does this premium exist, or is it merely a manifestation of survivorship bias?  If it exists, under what circumstances can it be captured? Does it pay to go active in EM small caps, or does indexing make more sense?

small caps

FTSE Global Micro Cap Index Series: Indexing the World (2018)
With the addition of this new index, FTSE Russell's GEIS now covers over 99% of the global equity market. This paper illustrates the country classification process that FTSE utilises and further aspects of index construction. 

Actively Benefiting from Emerging-Market Small Caps (Franklin Templeton, 2018)
(For compliance reasons, this paper is only accessible in the EMEA region)
Franklin Templeton explains why the EM small-cap space may still be an attractive proposition, despite common misconceptions about this asset class.

A Five-Factor Asset Pricing Model (Fama & French, 2014)
Eugene Fama and Kenneth French expound upon their original three-factor model (that included size as one of the three factors) by also adding a profitability and investment factor to the mix.

Year-End Factor Returns and the January Effect (FactorResearch, Dec 2017)
This study examines year-end effects on specific factors, and although these returns are difficult to extract due to illiquidity, certain factors (including size) were found to generate positive returns in early January.

Equal Weighting and Other Forms of Size Tilting (SSGA, 2017)
Like the value factor, small cap exposures can be a source of return, and we find that an equal weight strategy not only captures the size premium but also offers diversification potential through the reduction of specific risk.

Size Matters, If You Control Your Junk (AQR, 2015)
AQR uncovers specific weaknesses in the size premium and then attempts to re-examine a small-cap universe that is screened to exclude junk.

Don't overlook quality in small-cap investing (Eaton Vance blog, Jul 2018)
Eaton Vance discusses whether merely adding exposure to a small cap benchmark (such as the Russell 2000) will enhance returns to a large-cap stock portfolio and determines that quality also matters.

How Do Your Small Caps Really Create Value? (Intech Investments)
(For compliance reasons, this paper is only accessible in certain geographies)
Intech Investments investigates the outperformance of equal-weighted equity portfolios vs cap-weighted portfolios, showing that the performance disparity may be due to different reasons than initially expected. 

Market Pulse: U.S. Small Caps' Turn (QMA, Jun 2018)
QMA considers why US small-cap equities are having a big year and the reasons that their outperformance could continue. 

Re-Examining US Small Cap Equities in an Active Context (Manulife AM, Jul 2018)
(For compliance reasons, this paper is only accessible in the EMEA region)
Manulife Asset Management looks at the historical size premium and the active premium for small cap equities, along with current economic tailwinds.  

Small Wonders: Capturing the Potential of U.S. SMID-Cap Stocks (AB, 2017)
(For compliance reasons, this paper is only accessible in North and South America)
AllianceBernstein discusses the US SMID-cap sector, a sector composed of a combination of small and mid-cap equities with relatively thin coverage by Wall Street analysts. 

Reeling in Small-Cap Alpha (Research Affiliates, Nov 2015)
Research Affiliates discusses small-cap alpha generated from mispricing opportunities, factor strategies, and the potential high costs of passive implementation.

When Size Does Matter (Axioma, 2018)
Olivier d’Assier looks at a custom small-cap risk model for the Japanese market in order to determine whether small-cap managers should use a similar customised risk model in their investment processes.

Factor Returns within Small vs Large Caps (FactorResearch, 2017)
This factor study shows that while it is not the case that all factor returns are stronger in small caps, some factor returns could be more prevalent in this sector.

SSGA Long-Term Smart Beta Estimated Forecasts, Jan 2018
This report by State Street Global Advisors provides estimated Smart Beta forecasts for each of the four most prominent factors, including the size factor.