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Since 1926, US small cap value stocks have significantly outperformed the US total market. The annual CAGR for US small cap value since 1926 is 12.5%, compared to 10.5%1 for the S&P 500 (before inflation).
Increasingly, investors are advised to invest in a portfolio of market indexes, such as the S&P 500 (US large cap blend) and total market indexes.
Some investors avoid small cap value stocks (and small cap growth stocks) due to worries about higher risks and volatility. Historically, this fear is not completely unjustified as small cap value stocks are more volatile, with a standard deviation of 18% compared to 15% in the S&P 500 since 1976. However, surprisingly (while more volatile) small cap value has shown higher Sortino/Sharpe ratios than the S&P 500 over the last 50 years, possibly indicating better risk-adjusted returns2.
A number of studies and research highlight this long term outperformance, including the well known works of Fama and French3.
My questions:
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Is the higher risk nature of small cap value the reason investors avoid this tilt, instead generally having a preference for large cap/total market?
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Would this meet the typical idea of “performance-chasing”?
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If investing a specific tilt such as small cap value is considered “performance-chasing” even when scientific research has shown improved returns over 100 years, why then is investing in the total market not “performance-chasing”. People invest in the stock market because they believe it will return a long term CAGR of around 7% (because it has historically), aren’t they “chasing” that return as it is not guaranteed and treasuries for example would return a smaller but less “speculative” return? Where’s the boundary of “performance-chasing”?
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Why do you believe small cap value has outperformed?
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Why shouldn’t I have small cap value indexes as a main part of my long term portfolio?
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Is there a systematic problem investing in small cap value, am I missing some obvious downside?
Sources:
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https://www.aesinternational.com/blog/why-we-tilt-portfolios-towards-small-cap-and-value-stocks
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https://www.portfoliovisualizer.com/backtest-asset-class-allocation
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https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
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