A reader asks:
I was listening to WAYT and Josh mentioned and Michael seemed to agree that the small cap premium no longer exists (since the 1980s). I was hoping that this question can be discussed and dissected: What is this premium? Why doesn’t it exist anymore? How do you know? Is it still worth being owning small caps? My uneducated opinion was that small caps historically performed on par, if not better, than the rest of the market. Also, with the S&P 500 significantly outperforming small caps, it seems like being overweight on new contributions going into small caps doesn’t seem like a farfetched or irrational idea.
The Jeremys (Siegel and Schwartz) covered the small cap premium in the latest edition of Stocks for the Long Run.
They look at returns from 1926-2021. Small cap stocks outperformed large cap stocks 11.99% to 10.35%. But basically all of that premium came in one nine year window between 1975 and 1983 when small cap stocks were up more than 1,400% in total. Small caps outperformed large caps 35.3% to 15.7% per year in that time. Take away that outlier and the long-run returns are much closer.1
They explain why this happened:
One explanation for the strong outperformance during that period was the enactment of the Employee Retirement Income Security Act (ERISA) by Congress in 1974, making it far easier to pension funds to diversify into small stocks. Another was the turn of investors to buy small stocks following the collapse of the big-cap Nifty Fifty stocks earlier in the decade.
Fair enough. Although I’m sure if we exclude the 2016-2024 period of large cap outperformance, small stocks would look much better historically.
Let’s look at data over other time horizons to see how small caps have held up historically.
The Russell 2000
