Small Caps’ Collapse and What’s Behind It

A recent article in CityWire examines why the small-cap Russell 2000 index has underperformed its large-cap counterpart over the long-term, contrary to the widely accepted view introduced by Nobel laureates Fama and French back in 1992.

“Much has been written lately about growth versus value and what may, or may not, have changed,” the article says, outlining what it describes as the “small-large dichotomy.”

Here are some key takeaways:

  • One key reason for the performance variance is sector allocations, the article reports, with large caps having more exposure to “winning” industries. For example, the Russell 1000 is more heavily weighted in tech—“the best performing sector over the past decade,” and less heavily weighted in real estate and industrials compared to the Russell 2000.
  • But there is still hope for small-caps, the article argues, noting that “value-oriented sectors like industrials and real estate may start to improve against their growthier brethren.” It cites a new paper from Morgan Stanley that asserts “areas of the market where stocks have wide dispersions in returns offer the richest opportunities for active managers. Currently, small-cap stocks display the widest dispersion in returns and, therefore, the greatest opportunity set for active managers.”

But the wide dispersion of returns also presents a double-edged sword: It offers managers the opportunity to distinguish themselves but “also means the opportunity to fail is enhanced. Investors will have their work cut out for them in trying to identify potential winning funds.”