Small caps, big returns

Ulrich Urbahn, Head of Strategy & Research and Peter Kraus, Head of Small Cap Equities look at how, beyond market capitalisation, small businesses differ from large caps. It is these differences that determine the near- and medium-term relative performance of small companies and, in our view, speak in favour of adding small-cap exposure to the portfolio.

The Nobel laureates Eugene Fama and Kenneth French proved the existence of the “size” or “small cap” premium in 1993. The rationale behind the Fama-French three-factor model is that small caps – which we define as companies with a market capitalisation of €500m to €5bn – are riskier and more illiquid than large companies. Small caps should, therefore, offer investors additional returns for taking on this risk. Other studies have shown that small caps generate an excess return in the long term, even when adjusted for risk.

The development of small caps since the turn of the millennium fits the picture. They have grown by more than 250% – five times more than large caps. Small caps have outperformed large companies in 14 of the past 20 years. However, there have also been phases of relative underperformance, for example during the 2007-08 financial crisis.

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Ulrich Urbahn
Head of Multi Asset Strategy & Research
Peter Kraus
Head of Small Cap Equities