Perhaps Size Really Does Matter!

Source: CFA Institute, JQR Capital


Perhaps Size Really Does Matter!


The chart shown above is the long term (95 years) growth of $1 when invested in several different asset classes. It is often referred to as the Ibbotson SBBI chart - where SBBI stands for Stocks, Bonds, Bills, and Inflation. The asset classes depicted here include small capitalization US stocks, large capitalization US stocks, long term US corporate bonds, long term US government bonds, intermediate term US government bonds, and 30 US treasury bills (AKA cash). There are a few different themes from this chart that stand out to me:


  1. All asset classes showed positive growth over a very long investing period.

  2. The least risky asset class (cash) BARELY beats out inflation over the long haul.

  3. The more risk an investor is willing to take, the larger the ultimate gain.

  4. Sometimes it takes an iron stomach to finally earn the rewards.

  5. Past performance is no guarantee of future results.

Now Taking A Cross Section


The SBBI data and chart are very good tools to frame the asset allocation discussion with clients about which of the major asset classes is more worthy of investing their hard-earned dollars. This type of historical chart is often referred to as the longitudinal view of major US financial markets. I would like us to flip our “lens” 90 degrees right now and take what is called a cross sectional view of this information. Here we call into play some of the data published by Professor Ken French at Dartmouth College. This chart shows the investment performance of five different groupings of stocks over the 1927 to 2022 period. The groupings are formed by dividing the universe of US stocks (3,000+ stocks) into five equally weighted “quintiles” before each calendar year.


Source: Ken French, JQR Capital


The investment return of each quintile is then tracked during the next calendar year. The performance presented in the chart is the median annual gain for each of those five quintiles over that entire 95 year period. Quintile 1 represents the group of the smallest stocks at each sampling date and Quintile 5 represents the group of the largest stocks each year. One thing you may notice is that very small performance advantages in smaller stocks evident in this quintile chart get magnified in the top SBBI chart due to the long term compounding effect.

Zooming Further Into The Weeds

If we pull out our magnifying glass and further refine our stock groupings at each annual selection date, we see that this size effect is even more pronounced when dividing our stock universe into ten equally weighted groups called “deciles.” The chart shown below is the refinement of the quintile chart and again we see that the smallest of the small delivered much better median annual performance than the rest of the stock universe. When we calculate the difference between the smallest decile (19.06%) and the largest decile (11.14%) we are left with a 7.92% advantage.


Source: Ken French, JQR Capital


Market capitalization (share price * shares outstanding) is the most common way to measure the size of a company and their influence on the “market” - insert your favorite market index here. Some think that the Dow Jones Industrial Average of 30 stocks is the best measure of “market” performance. Others profess that the Standard & Poors 500 is a better index with which to judge equity health. I suggest that the best inclusive measure is the broadest index that includes as many investable stocks by the average individual investor. For many of us, this points toward the Wilshire 5000 index.


One of the morals of this story is that all large companies started out as small companies. Apple did not just apparate into a 3 trillion dollar giant. Another key takeaway is that the large household names tend to grow at a much slower rate than the smaller companies (whose names we may not even be able to pronounce, YET). The final lesson - which may be the most valuable one - is that it often takes 20 years to build an overnight success.

References

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3893876

https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

https://www.investopedia.com/terms/w/wilshire5000equityindex.asp

https://www.brainyquote.com/topics/overnight-success-quotes


Location: 23 Foxridge Rd, West Hartford, CT 06107, USA

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