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Small Cap Return: The Size Premium in European Markets

The Financial Times recently published an article comparing the performance in the U.S. of the Large Cap S&P 500 and the Small Cap Russell 2000.  They found that over the past 10 years the two indices provided the same total return.  Investment theory suggests that small cap companies should outperform large cap companies.  Small caps are assumed to be inherently riskier leading investors to demand greater returns.  This is known as the size premium.  However, the size premium has been a divisive topic over the years and once again is under attack. 

How does the size premium look over a similar period in Europe?  We looked at the returns of large and small capitalization portfolios in S&P BMI Europe Developed and Emerging Markets over the past 10 years. The green line shows the performance of the smallest 20% of companies.  The red line shows the performance of the largest 20% of companies.  Finally, the black line shows the performance of a portfolio which is long the smallest 20% of companies and short the largest 20% of companies.  These portfolios are all rebalanced monthly and equal weight the underlying securities.  We found that small cap companies have consistently underperformed their large cap counterparts over the past 10 years in Europe.  This has been particularly pronounced post financial crisis, as investors have generally been more risk averse.

Source: S&P Capital IQ Alpha Factor Library.  Style investing in the S&P BMI Europe Developed Indices From 9/2004 – 9/2014.  For illustrative purposes only.  Indexes are unmanaged, statistical composites. It is not possible to invest directly in an index. Backtested returns do not represent the results of actual trading and were constructed with the benefit of hindsight.  Returns do not include payment of any sales charges or fees. Inclusion of fees and expenses would lower performance.  Past performance is not a guarantee of future results.

Looking at the return spread between small and large cap companies over the past 5 years on a country by country basis, we see that the underperformance is relatively consistent across Europe.  Austria and Belgium are the only countries where small cap outperformed large cap over this period with average 1 month return spreads of 0.68% and 0.18% respectively. It’s apparent that European small cap stocks have had a rough time as of late, and the debate around the size premium has persisted although there is evidence that suggests the premium has not. 

Source: S&P Capital IQ Alpha Factor Library.  Style investing in the S&P BMI Europe from 9/2009 – 9/2014.  For illustrative purposes only.  Indexes are unmanaged, statistical composites. It is not possible to invest directly in an index. Backtested returns do not represent the results of actual trading and were constructed with the benefit of hindsight.  Returns do not include payment of any sales charges or fees. Inclusion of fees and expenses would lower performance.  Past performance is not a guarantee of future results. 

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