The relatively high transaction costs associated with small cap stocks combined with forecasted returns that are not expected to exceed those of large cap stocks make the asset class relatively unattractive at this time, according to a recent study by BNY Mellon Beta Management, a BNY Mellon Asset Management business.
The study calculated expected returns for small cap and large cap stocks in the US and other developed global markets by examining the current price of individual securities, consensus earnings expectations over the next few years, and the long-term growth rate for the gross domestic product for the countries in which each company is based.
Mark Keleher, CEO of BNY Mellon Beta Management, said: “In the US, we believe the expected returns premium for small caps is zero when compared with large cap stocks. This means that an investor would not receive excess compensation for investing in a less liquid market.”
The last time this occurred was in March 1983. The large-cap Russell 1000 outperformed the small-cap Russell 2000 in terms of price appreciation by an average of 48 basis points annually over the subsequent 27 years according to the study.
However, there have been several periods of small caps outperforming large caps in that time frame, the BNY Mellon Beta Management white paper noted.
In assessing global small cap stocks, the report concluded that expectations are lower than they are for global large caps.
The white paper reported that transaction costs are estimated to be approximately 14 basis points higher for US small caps compared with US large caps and even higher in other global developed markets as turnover tends to be higher in small cap indexes and small cap active portfolios than their counterparts at large cap indexes and large cap active portfolios.
Mr Keleher added: “We’re not saying that small caps are always a bad investment. There tend to be periods where small caps outperform, but this does not appear to be one of them. Small caps in developed global markets did particularly well in the 12 months ended May 31, 2010, when they out-performed global large caps by over 15%. However, our study indicates the optimum time to invest in small caps may have passed.”