So, there is a long foundation of academic research that suggests smaller stocks add return to a portfolio and that the smallest of those stocks add the most return. While small and micro cap stocks may experience significant volatility over short-term periods, investors who hold these same stocks over longer periods of time have experienced better risk-adjusted returns than what they would have received if investing in larger-company stocks during similar periods. The four portfolios with the lowest market caps provided risk-adjusted average annual excess returns of 1.69% to 5.54%, while the remaining six portfolios with the larger company stocks each generated negative annual excess returns ranging from -0.12% to -4.12%. They divided 3,130 stocks into 10 portfolios, each containing an equal number of stocks, on the basis of market cap. In another study professors Thomas Cook and Michael Rozeff from the University of Iowa examined the small-firm effect using stocks listed on the NYSE, Amex and those traded over-the-counter (OTC) over the period 1968 to 1978. On the other hand, the portfolio containing the smallest NYSE companies provided a risk-adjusted excess rate of return of about +6% a year. Over the 50-year period 1926 through 1976 he studied, Banz found that the four portfolios containing the largest NYSE firms generated an average risk-adjusted excess annual return of -0.72%. In a later study, Banz created five portfolio segments containing the largest to smallest stocks listed on the New York Stock Exchange (NYSE). However, Banz and others found, when adjusted for risk, the returns for small-company stocks still outperformed those of larger stocks. The smallest stocks which comprise the bottom 20% of market capitalization, had an average annual standard deviation of 42.1% from 1926 to 2015, compared to 19.1% for the largest 20% of stocks. Small-company stocks do possess more risk than do large-firm stocks on an absolute level. One of the often-cited counter-argument to investing in smaller companies is that they are riskier, and this added risk is the reason for their higher returns. In other words, the smaller a public company, the better its potential return. His findings show that the size of a firm and the return on its common stock are inversely related. Banz suggested that company size was a contributing factor to its stock’s return. One of the first important studies related to the small-cap effect was “The Relationship Between Return and Market Value of Common Stocks” by Rolf Banz in 1981. Market capitalization is the key indicator in many of these studies and is often cited as a return differentiator. One of the most widely discussed and researched topics in finance academia is the “small-firm effect.” Dozens of research studies have been published looking at all aspects of the theory that investing in smaller companies will generate superior returns when compared to investing in larger stocks, given the same level of risk. There are a number of return and correlation benefits that micro cap investors should understand. The positive sentiment and operating environment around the micro cap space is not the only reason to own these opportunities in a multi asset portfolio. The index came in at 107.9 in May, a 45 year high for the benchmark.
In addition, small-business confidence continued to hit record highs in 2018, according to the National Federation of Independent Businesses latest index of small-business optimism. The stories of tax savings alone in the micro cap space continue to be compelling. Many tax paying micro cap companies, unable to use the complex tax strategies available to larger multinational entities, often pay taxes at or near the maximum marginal tax rate. The completion of corporate tax reform provided a material increase in cash flow for most of the companies in our portfolio and many more public and private small businesses across the country. The interesting alignment in market conditions that pointed to the potential for higher valuations, driven by better operating performance and increased M&A activity. In our yearend 2017 Micro Cap Outlook Report we discussed the idea that the conditions could be primed for a “perfect storm” in the micro cap space. Micro cap stocks dramatically outperformed the broader market during the first half of the year with the micro cap indices up about +11% with the broader markets up approximately +3%. The rewards are inversely proportional”.įor the year-to-date period ended June 29, 2018, the preliminary estimated investment results for the Uniplan micro cap portfolio are as follows: