Small caps outperform large-caps

Introduction

Not as often covered by the press, small-caps are often overlooked by investors. They are not as well-known as their large-caps neighbors and are often deemed as risky.

Large-caps are listed in the famous S&P 500 index which is the most famous stock index in the world and the standard performance benchmark for portfolio managers.

Small-caps also have their own index, the S&P 600. As defined by the S&P 600 index they are stocks with a valuation between $85 million and $4.3 billion.

Another well-known small-caps index is the Russell 2000 a subset of the Russell 3000 index which comprises the top 3000 stocks in the US stock market.

Performance

Over the last five years the small-caps index S&P 600 performed better than the S&P 500. On average the former rose 12.98% annually while the latter only rose by 11.66%.

Due to their size small-caps have more room to grow and are more nimble to make the necessary changes in their strategy and adapt to challenging economic conditions.

Analyst coverage

The number of analysts covering S&P 600 companies is low compared to those covering the ones in the S&P 500. Less light is shed on their financials, strategy and results and thus they offer more reward potential.

Over a sample of 30 companies in each index the average number of analyst opinion given during the current month is 24 for S&P 500 companies while only 6 for S&P 600 stocks.

Small-caps are not as well researched as their bigger counter-parts and might effectively be big-caps in the making.

Investment

One can invest in such a performance by buying ETFs covering small-caps or buying a portfolio of companies listed in the S&P 600 index.

One of the index funds available is the SPDR (SLY) which boasts a 12.73% after taxes average annual performance.

Risks

With higher rewards come higher risks. Volatility is higher in the S&P 600 index with a standard deviation of 2.53% against 1.93% for the S&P 500.

Otherwise risks are relatively low. Shares listed in the S&P 600 are required to have adequate liquidity. The index as a whole is also well diversified.

The S&P 500 and its small-caps equivalent are both well diversified but not in exactly the same way. The former is dominated by the IT, financials and health care sectors which constitutes more than 50% of is weight. the latter has the financials, IT and industrials as its top three.

Sector Breakdown