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The Size & Value Premiums


Over the long term, small-cap stocks have generated higher returns than large-cap stocks (+3.3 percent annual average, 1927–2015), while value stocks have outperformed growth stocks (+4.8 percent annual average, 1927–2015).* There is abundant academic evidence that these size and value premiums exist across multiple asset classes and stock markets. Utilizing stock and alternative funds that aim to capture long-term return premiums like size and value can increase the expected return of these asset classes over long time periods, allowing investors to take less overall equity-market risk in their portfolios.

Small-cap value stocks are performing well in 2016 as evidenced by the +15.5 percent year-to-date return for the Russell 2000 Value Index, which compares favorably to the return of U.S. large-cap growth stocks (Russell 1000 Growth is +6.0 percent). But just like individual asset classes, factor premiums are expected to experience large positive and negative years, as well as extended periods of outperformance and underperformance. For example, U.S. value stocks underperformed U.S. growth stocks by 32.0 percent in 1999, the worst relative performance year for value over the past 89 years. This was followed by a positive value premium of 39.4 percent in 2000 (the largest over the same time period), which was the first of seven consecutive years with a positive value premium (annual average of 14.8 percent). Likewise, the small-cap premium was positive every year from 1975 to 1983 (annual average calendar year premium of
+13.8 percent), before turning negative in 10 of the next 15 years (annual average of –4.5 percent).

There is no crystal ball telling investors when a given premium will be positive or negative, but diversifying across multiple factor premia should improve the risk-adjusted performance of a portfolio over long periods of time. The tables below show that while there can be long cycles of negative premiums for both size and value, patient investors are likely to be rewarded for staying disciplined.

Jeff Griswold