![]() So perhaps the markets are less efficient. It could also be argued that the opportunities for arbitrage are less among small caps. A simple reason could be that factor dispersion is greater further down the size spectrum and therefore the characteristic differences are larger. What happens to other factors lower down the size spectrum? Generally, says Quigley, researchers would argue that factor effects get stronger further down the capitalisation scale. But when equity markets fall, small caps underperform large caps and the small caps re-correlation to equity markets as a whole increases at the very time when that is what is least wanted. He is not keen on trying to harness the effect because for his firm the most important risk to control is re-correlation risk, especially on the down side.ĭumontier accepts that over the long term, small caps will tend to outperform large caps. What is important, though, says Quigley, is that sector groupings are not narrowed or distorted too much by extreme concentration to small caps – by having a more balanced exposure across sectors, the returns from the size effect can be improved.Ī more serious criticism of the small-cap effect is voiced by Luc Dumontier, head of factor investing at La Française Investment Solutions (LFIS). You can get a healthy premium from mid caps as well as small caps.” “Historically people had thought that the small-cap effect was limited to 5% or 10% of the market – you really had to dig into the small caps to get a premium,” says Quigley. Yet, says Garrett Quigley, managing partner of Global Systematic Investors (GSI), numerous researchers have shown the size effect is not confined to small and micro stocks but there is also a big uplift in mid-cap stocks. Much of that noise is associated with illiquidity and hence the poorer quality of price information. If there is a size effect it comes with a lot of volatility, says Mark Roemer, a portfolio manager at Acadian Asset Management. But small-cap investing still raises many challenges because of the illiquidity and associated raised transaction costs. The small-cap effect, with smaller companies tending to outperform larger ones over time, has been well known for decades and subject to much academic research. ![]() Combining the smaller company effect with ESG is challenging.The small-cap effect is often particularly pronounced in emerging markets as investors bid up the price of larger and more liquid stocks.There is a negative correlation between the small-cap effect and quality.Although the evidence for the smaller company effect is strong the transaction costs needed to harness it are high.
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