Small Cap Value: Risk and Returns
Posted March 29, 2011on:
If you invested $1 in the small cap value index at the beginning of 1927, you would have had $52,892 by the end of 2010. This is according to the recently published Dimensional Fund Advisors’ annual Matrix Book. Included in the book are historical risk and returns of various indices based on capitalization and book-to-market valuation.
Table 1 presents a summary of historical returns. The best returns are marked in green; the worst, marked in red. As one can see, the small cap value index is the best for all the periods considered. And it is the best by a huge margin.
Table 1: Small Cap and Large Cap Historical Returns
|1 y 2010||5 y 2006-2010||10 y 2001-2010||20 y 1991-2010||50 y 1961-2010||80 y 1931-2010|
|Small Cap Value||34.6||4.8||13.8||15.6||15.3||15.4|
|Large Cap Value||20.2||-3.7||-0.1||8.2||11.4||11.2|
|Small Cap Growth||31.8||3.4||3.0||8.2||8.2||10.2|
|Large Cap Growth||17.6||3.9||-0.4||8.5||8.9||9.4|
There are two possible explanations for this:
1. Small cap value is more risky
2. Investors systematically undervalue small cap value
Academics tend to accept 1) while practitioners tend to argue for 2). Let the data be the final arbitrator.
In Table 2, I sum up the worst 1-year, 5-year, 10-year and 20-year returns of the various indices and use them as proxies for risk. I then use red to mark the most risky index and green to mark the least risky in a given period. One can see, the small cap value index is the most risky for all durations except one.
Table 2: Small Cap and Large Cap Historical Risk
|Worst1 year||Worst5 years||Worst10 years||Worst20 years|
|Small Cap Value Index||-60.6||-24.9||-7.5||2.4|
|Large Cap Value Index||-53.1||-21.7||-5||3.3|
|Small Cap Growth Index||-45.1||-19||-2.5||2.0|
|Large Cap Growth Index||-43.7||-15||-4.1||3.0|
This proves once again that risk and rewards go hand in hand. Put it in layman’s term, the better you can put up with short term drop, the more you will earn long-term returns.
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