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Do Small Caps Still Outperform Large?

Smaller public companies appear to be an endangered species, but Dimensional Fund Advisors argues that the size premium is still on offer.

  • By Julie Segal

With the number of smaller listed companies in the U.S. a fraction of what it was two decades ago, investors have debated whether the size premium — smaller stocks outperforming larger ones — exists.

The size premium is one of a handful of equity factors, including value and growth, that tend to deliver higher average returns than markets overall, according to decades of academic research.

In a study released today, Dimensional Fund Advisors found that the decline in the number of public listings has not affected the size factor. “We believe investors should continue to expect a positive size premium over the long term,” the authors wrote. 

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The number of listed stocks in the U.S. has declined dramatically, from more than 7,000 in 1997 to its current level of about 3,400. Dimensional argued that this drop-off has been countered by the increase in public listings outside the U.S. That number is now 39,000, up from approximately 9,700 in 1990. 

“We find no evidence that its existence or magnitude has been related to the number of listed stocks. Regardless of the number of stocks in a market universe, research shows that investors can rely on information in market prices to identify securities with higher expected returns,” according to the report. 

Dimensional analyzed monthly stock premiums in developed markets from 1982 to 2017. The markets each had a very different number of listed stocks available to investors during the time period. Markets such as Ireland had 55 stocks on average; Italy had 233 stocks and the U.S. had 3,763, according to Dimensional. Ireland had a monthly premium in smaller companies of .47 percent, while Italy had an average .15 percent. The premium available to investors was .18 percent. 

To explore whether a smaller number of public stocks would affect the premium, Dimensional examined markets over the last four decades as if they contained only the 3,400 companies available today. “Within a hypothetical universe of the 3,400 largest names, the size premium was 2.22 percent (annualized) from 1975 to 2017,” the study found.

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