Small cap stocks which ignited in September have been under pressure since then. However, small caps represents a very attractive investment segment and offer a very compelling reason for a long-term portfolio allocation – outperformance. Small caps simply outperform other stock market segments and asset classes over the long-term.
The Enduring Power of Small Caps
Small-cap stocks are generally defined as companies with a market capitalization of between $250 million to $2 billion.
However, the definition is not firm. For instance, the Russell 2000 index, the most popular small cap benchmark used by asset management institutions, does not use a market cap cutoff. Instead, the Russell 2000 index comprises the smallest 2000 companies in the Russell 3000 index, which in turn, comprises the largest 3000 US publicly-held companies representing 98% of the US stock market capitalization. Consequently, the average market cap and the market cap range of the small cap Russell 2000 index changes based on the market performance during a year. Every June the index is reconstituted. As of the end of September quarter, the average market cap of Russell 2000 was $2.2 billion and the median (midpoint) was $850 million. Another popular small cap index, the S&P SmallCap 600, is also a capitalization weighted index with a small cap market cap range of $450 million to US$ 2.1 billion.
The Graycell Small Cap Portfolio uses a market cap range of $200 million to $3 billion in its model portfolio.
There has been a large body research over the years providing empirical evidence for the outperformance of small caps on both an absolute and risk-adjusted basis over time.
The work of Nobel laureate Eugene Fama and many others have quite decisively concluded the outperformance of small cap companies compared to larger caps. The outperformance to an extent depends on time frames, whereby in some periods small caps may outperform while underperforming in others. However, when measured over an extended period of time, the small cap outperformance is abundantly clear and consistent.
