The Investment Scientist

Posts Tagged ‘large cap

ImageAccording to Nobel Laureate Eugene Fama, there are three major risk premiums.

1. Equity premium is the additional “wage” one can earn from taking stock market risk over not taking stock market risk.

2. Small cap premium is the additional “wage” one can earn from taking small company risk over taking large company risk.

3. Value premium is the additional “wage” one can earn from taking non-growing company risk over taking growing company risk.

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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.

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Recession Stock Market

Three years ago, at the onset of the recession, I performed research analyzing the previous nine recessions after WWII and wrote an article “Recession and Stock Market Performance” based on that research.

Given that I am not clairvoyant – unlike many market pundits and some fellow financial advisors – I can’t see the future. I can only use my research of the past to frame my perspective of the future.

I came away with two conclusions:

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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