At MWA, one of our core investing beliefs is that risk and return are related. As such, there are three known investment factors that offer higher returns to long-term, patient investors. One of these factors is that small companies offer nearly a 3% annual premium compared to big companies. While this is well known, few investors capitalize on the extra return offered from owning smaller companies.
In this article, Jason Zweig (one of my favorite financial writers), explains that US markets currently have half as many small companies as they did just two decades ago. He explores the effects of this trend, some of the reasons for it, and why investors that capitalize on it are still likely to be rewarded for investing in this factor (assuming they keep their total costs low and maintain extremely broad diversification).
I thought Zweig’s most interesting point — a point we totally believe in — is that investors who have maintained exposure to micro caps (which make up about 2% of stock market values) have received investment returns roughly equal to private equity funds. These have very high cost and no liquidity, and they are very complex vehicles that utilize leverage and borrowed money to boost returns. Complexity and high cost are rarely an investor’s friends. I think this article helps substantiate one reason why tilting portfolios to small companies (one of the three equity factors that drive higher expected returns) has worked in the past and is still working today, even though half as many companies are publicly traded.
Enjoy Jason’s article HERE