Newspaper article The Journal (Newcastle, England)

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Newspaper article The Journal (Newcastle, England)

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Byline: Andrew Miller

THE idea of a small-cap premium goes back to 1981, when Rolf Banz stated: "In the 1936-1975 period, the common stock of small firms had, on average, higher riskadjusted returns than the common stock of larger firms."

Professors Eugene Fama and Kenneth French also that found that small stocks had higher average returns, and they believed the higher returns were compensation for risk.

Since the late 1990s, the smallcap thesis has been questioned. There has been criticism of Banz's original work: the small-cap premium that Banz discovered was based on a handful of performance bursts, not consistent outperformance.

There is also the question of to what extent the excess returns of small-company stocks disappear when taking higher transaction costs into account.

So the idea that small-cap stocks offer a higher risk-adjusted return is now firmly in question.

But, even if they did, one economist comments that: "After they are documented and analysed in the academic literature, anomalies often seem to disappear, reverse, or attenuate."

For the US market, a look at the Russell 2000 index is probably the most appropriate place to find the answer. As of Dec 31, 2013, approximately 97% of institutional US small-cap products were benchmarked against the Russell 2000. The index represents the 2000 smallest stocks of the Russell 3000 index. For its 35-year history, there is not much evidence of a compensated risk premium - overall annual returns are both 12% and leadership was split evenly. Small caps led for 18 of those years, while large/mid caps led for 17 years.

Small caps had a run of consecutive years of leadership, from 1979 through 1983, in the time before publication of the index. Since then, the US small-cap index actually underperformed the large/mid cap by 1.3% annually.

In the past, there have been prolonged leadership cycles with small-cap stocks leading in the early 1980s, early 1990s and for most of the first half of the next decade. …

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