Beneath the title of this paper the late Benny Hill would have been proud to compose [Benny who? Really? This will either remind or introduce Benny Hill – Classic Chase. Part of my nation’s rich cultural legacy…] is a very important argument for any who have been persuaded that small-caps aren’t worth the trouble.
The small-cap, or as it’s properly known and will be referred to hereafter, the size-effect was ‘discovered’ in the early 1980s. At that time a consensus emerged that small caps was where consistent juice could be found; but ever since then the argument has been under attack (propelled in part by an asset management industry compelled to operate mostly in big-cap land I suspect?). The last iteration of this argument I saw ‘proved’ that big caps was where the best risk-adjusted returns are to be most reliably harvested. Confused? Me too.
The paper highlighted this week by Mr. Cliff Asness (et al) of AQR Capital Management takes on the seven most often tossed barbs at the size-effect and shows that when adjusted-for-quality-analysis is applied the size-effect comes out stronger than ever.
The root cause of the muddled thinking is that when taken in aggregate small companies tend be on the junky side so studies that scoop them all together find them poor performers. Take out the feeble and sick though, which is what this study does, and it shows quality smaller cap companies are consistent outperformers over time.
The bottom line for investors seems to be if you can find good quality smaller companies who are enjoying a measure of success with their business you’ll do consistently better than in big-cap land [Simple, right? :-)]. Which shouldn’t be the case if you believe in a CAPM world [Me? So not!] where there are no free lunches. Mr. Asness and his collaborators seem to convincingly demonstrate that there are indeed dollars yet to be found on the sidewalk.
Happy Sunday
[You can access the paper in full via this link Size Matters. I found this one especially heavy going so if you’re sufficiently interested you might like to start with a more detailed synopsis I found at FT Alphaville – Excellent Summary of Size Matters, you’ll have to register but it’s free.]