Small caps

From Bogleheads
Revision as of 21:47, 28 April 2020 by Blbarnitz (talk | contribs) (→‎Vanguard index fund returns: updated table)
Jump to navigation Jump to search
Flag of the United States.svg.png This article contains details specific to United States (US) investors. It may not apply to non-US investors.

Stocks may be classified by the size of the corporation. This is most commonly done looking at the market capitalization. Market capitalization is simply a measurement found by taking a stock's current share price and multiplying it by the number of stock shares outstanding. Exact market cap ranges will vary among different financial and rating institutions, [note 1] but there are three different terms commonly used to describe stocks by their general size large cap stocks; mid cap stocks; and small cap stocks. Market cap terms are relative and are constantly changing as companies get bigger and smaller.

Table 1. Market Capitalization
Size Characterization Capitalization Range
Large Capitalization Stocks over $10 billion dollars
Mid Capitalization Stocks between $2 billion and $10 billion dollars
Small Capitalization Stocks between $300 million and $2 billion dollars

Capitalization ranges for companies that are smaller than small cap stocks include micro cap and nano cap stocks.

Table 2. Market Capitalization
Size Characterization Capitalization Range
Micro Capitalization Stocks between $30 million and $375 million dollars
Nano Capitalization Stocks below $50 million dollars

Risk and returns

US markets

Beginning with Rolf Banz in 1981[1] and continuing with Eugene F. Fama and Kenneth R. French in 1992 and 1999[2], academic studies have found that US small cap and US small cap value stocks provided premium returns during the twentieth century. These premium returns were accompanied by greater risk. (See Table 3. and Table 4. below). While US small cap stocks provided a 2% premium return over US large cap stocks over the twentieth century, small cap stocks declined a real -70% over three years during the Great Depression and declined a nominal -90.78% (1929 - 1932) and -53.15% (1972-1974).

Table 3. Historical Returns and Risks of U.S. Stocks in the 20th Century [3]
Asset Annualized Return Worst Real Three-Year Loss
Large Company Stocks 10% -60%
Small Company Stocks 12% -70%
Table 4. Small vs. Large, July 1926 - June 2000 [4]
Asset Annualized Return 9/29 - 6/32 12/72 - 9/74
Small Stocks 12.35% -90.78% -53.15%
Large Stocks 10.91% -84.44% -43.47%

In addition to a size premium, twentieth century returns showed the presence of a realized value premium. The 1926 - 2000 return of US small value stocks was 14.87% as compared to the 9.92% return of US small growth stocks.[5] Figure 1. shows the growth of a dollar investment in each of the four quadrants of market capitalization from 1927 - 2000. For investors to attain these premium returns required long term holding periods, as the market, value, and size factor returns often rotate over time and there are long periods when portfolio tilts to small and small value stocks lag the market.[6]

Prospective risk premium

The prospective risk premium for small cap and small value stocks is subject to debate. Classic financial theory argues that reliable future premium returns must be based on compensation for risk or there is the possibility that, because the premiums are known, they can be arbitraged away. Behavioral economists[7], have posited behavioral reasons[8] for the historical risk premiums.

Others (John Bogle) have expressed doubts as to the viability of the small cap and small value premium:[9]

From 1925 through 1964 - a period of fully 39 years - small caps and large caps provided identical returns. Then, in just four years, through 1968, the small-cap return more than doubled the large-cap return. Virtually that entire margin was lost during the next five years. By 1973, small caps were about at par with large caps for nearly the full half-century. The small caps' reputation was made largely during the 1973-1983 decade.

— John Bogle[10]

Bogle also cites the high transaction costs in executing small cap portfolios as a hurdle for realizing small cap premiums. According to Edelen, US large cap fund have transaction costs (mean 0.77%, median 0.55%); US small cap funds have transaction costs (mean 2.85%, median 2.33%)[11]

Vanguard index fund returns

Since 1975, investors have been able to index US large cap stocks. Since the early 1990's investors have been able to index US market, US small, US small value and US small growth stocks. The returns of Vanguard funds are provided in the following three tables. Table 5 shows returns in the 1990's, a period dominated by the returns of large cap growth stocks; Table 6 shows returns in the 2000's, when small cap and value stocks provided premium returns; and Table 7 provides returns for the decade spanning 2010 - 2019 when large cap and growth stocks outperformed small cap and value stocks. The apparent anomaly of higher period (1990-1999) returns for the Vanguard Small Cap Index Fund over its constituent value and growth index returns is due to Vanguard using, until May 2003, the Russell 2000 Index for the small cap fund and S&P style indexes for the small value and small growth funds. From May 2003 to 2014 all three funds were indexed to MSCI indexes; since 2014 the funds have been indexed to CRSP indexes.

Table 5. Vanguard Funds 1990 - 1999 Bull Markets [12]
Fund Annualized Return
Total Stock Market 17.47%
S&P 500 18.08%
Small Cap 13.99%
Small Cap Value 12.74%
Small Cap Growth 11.26%
Table 6. Vanguard Funds 2000-2009 Bear Markets
Fund Annualized Return 2000 - 2003 2008
Total Stock Market -0.27% -37.07% -37.04%
S&P 500 -1.03% -37.71% -37.02%
Small Cap 4.35% -19.74% -36.20%
Small Cap Value 7.69% 18.90% -32.11%
Small Cap Growth 4.84% 5.06% -40.00%
Table 7. Vanguard Funds 2010 - 2019 Markets [13]
Fund Annualized Return
Total Stock Market 13.50%
S&P 500 13.40%
Small Cap 12.81%
Small Cap Value 11.77%
Small Cap Growth 13.50%

International markets

Research into international stock market performance over the last quarter/half of the twentieth century provided evidence of a realized small cap premium. Hawakini and Keim (2000), in a study of 16 international markets[14] found evidence of a small cap premium in 15 of the 16 countries (the exception being Korea, which provided a monthly -0.40% small cap discount). The positive monthly premium ranged from 0.41% in Singapore to 4.16% in Mexico. The data series in the study varied, with most study periods ending in the 1980's to 1990. As Dimson, Marsh, and Staunton report, subsequent to the publication of these findings, the small cap premium reversed in international markets during the 1990's.[15] In reference to UK markets, they note:

Using a new dataset of accounting information merged with share price data we find a strong value premium in the UK for the period 1955-2001. The value premium exists within the small-cap as well as the large-cap universe. We also find that dividend yield as a measure of value produces strikingly similar results. The time-series of return spreads between portfolios sorted according to dividend yields closely matches the results obtained from sorts on book-to-market. However, managers attempting to capture the value premium in the small-cap segment should pay particular attention to rebalancing-induced portfolio turnover and market illiquidity in small-value stocks. Compared to the U.S., the U.K. market for small-cap stocks is relatively illiquid. Trading costs are therefore an even more crucial determinant of overall performance. This is likely to be the case in other non-U.S. markets as well."

— Dimson, Elroy, Nagel, Stefan and Quigley, Garrett,[16]

The 2000's have witnessed premium returns for international small cap stocks as evidenced by the performance of MSCI EAFE indexes. Small cap international stocks demonstrated lower correlation to US large (0.72 vs. EAFE 0.86) and US small (0.71 vs. 0.76 EAFE) stocks during the 1999-2008 period.[17] The case for persistence in lower correlation for small cap international stocks is the tendency for small cap stocks to be economically tied to local national economies as opposed to being global enterprises.

Table 8. MSCI US & EAFE 2000-2009 Returns
Index 1-year 3-year 5-year 10-year
International Large Cap 31.78% -6.04% 3.54% 1.17%
International Small Cap 42.51% -9.67% 1.30% 4.30%
US Large Cap 27.80% -5.06% 1.02% -0.94%
US Small Cap 36.15% -4.21% 1.81% 6.21%

As is true in US markets, international small cap stocks incur higher transaction costs compared to large cap stocks. Quigley provides transaction cost breakdowns for regional markets.

Table 9.Transaction Costs [18]
Continental Europe Japan Pacific Rim United Kingdom
Large Cap Spreads 0.34 0.91 0.88 0.61
Small Cap Spreads 2.90 2.24 3.71 4.26

Expected return estimates

According to 30 year return estimates from William Bernstein and Rick Ferri small cap stocks can be expected to provide the following returns:

Table 10. Sources: Portfolios Solutions [19] and The Four Pillars of Investing [20]
Asset Real Returns With 3% Inflation Risk (Standard deviation)
US Small Cap Stocks 5.0 - 6.0 8.0 - 9.0 20.0
US Small Value Stocks 7.0 - 8.0 10.0 - 11.0 25.0
International Small Company Stocks 5.0 - 6.0 8.0 - 9.0 22.0

Small cap funds

Vanguard small cap funds

Vanguard offers the following small cap funds. Note that the Vanguard CRSP based small cap funds, as well as the international small cap fund are also available as ETFS.

Table 11. Vanguard Funds
Active Index ETF
Strategic Small-Cap Equity (active small blend) VSTCX Small cap index NAESX Russell 2000 ETF VTWO
Explorer (active small growth) VEXPX Small cap index Admiral shares VSMRX Russell 2000 Growth ETF VTWG
Explorer Admiral shares VEXRX Tax-managed small cap index VTMSX Russell 2000 Value ETF VTWV
Explorer Value (active small value) VEVFX Small cap growth index VISGX S&P Small Cap 600 ETF VIOO
International Explorer (active international small growth) VINEX Small cap value index VISVX S&P Small Cap Growth 600 ETF VIOG
FTSE All World ex. U.S. Small Cap (International) Index VSFVX S&P Small Cap Value 600 ETF VIOV

Index funds and ETFs

Altruist FA provides a handy listing of investment options for small cap stocks:
-- Altruist Financial Advisors LLC

In addition to Vanguard, Schwab and Dreyfus offer no-load US small cap index funds. According to, a total of 39 small cap ETFs are currently available. The major ETF managers are included in the table below. One should note that Powershares ETFs are indexed to proprietary quasi-active indexes (the Intellidex and Zacks series).

Table 12. Major Providers US Small Cap ETFS
Firm ETFS Index Providers
I shares 10 Morningstar, Russell, S&P
Powershares 5 Intellidex, Zacks
Rydex 2 S&P Pure Style
Spdr(drop down menu) 3 Dow Jones
Vanguard 9 CRSP, Russell, S&P


  1. Index providers divulge market cap ranges in rule books.

See also


  1. Rolf W. Banz, "The Relationship Between Return and Market Value of Common Stocks," Journal of Financial Economics, 9 (1981), pp. 3-18
  2. Davis, James L., Fama, Eugene F. and French, Kenneth R., "Characteristics, Covariances, and Average Returns: 1929-1997" (February 1999). Center for Research in Security Prices (CRSP) Working Paper No. 471. Available at SSRN: or DOI: 10.2139/ssrn.98678
  3. William Bernstein, The Four Pillars of Investing
  4. William Bernstein, The Four Pillars of Investing
  5. William Bernstein, The Four Pillars of Investing
  6. William Bernstein, Factor Rotation, Efficient Frontier, Summer 2000.
  7. See Haugen for a review)
  8. Behavioral investing pitfalls
  9. John Bogle, The Telltale Chart
  10. John Bogle, Large-Cap Stocks vs. Small-Cap Stocks,Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor, John Wiley & Sons (© 2000)
  11. Edelen, Roger M., Evans, Richard B. and Kadlec, Gregory B., "Scale Effects in Mutual Fund Performance: The Role of Trading Costs" (March 17, 2007). Available at SSRN:
  12. Simba's backtesting spreadsheets
  13. Simba's backtesting spreadsheets
  14. Hawakini, Gabriel and Keim, Donald B., "The Cross Section of Common Stock Returns:A Review of the Evidence and Some New Findings ". Wharton 1999.
  15. Dimson, Marsh, and Staunton, Triumph of the Optimists:101 Years of Global Investment Returns, Princeton University Press, 2002. pp.131 -135.
  16. Capturing the Value Premium in the UK 1955-2001(January 2003)
  17. Gordon Johnson, Shannon Ericson, and Vikram Srimurthy,Diversification Benefits of International Small-cap Stocks, Lee Munder Capital Group
  18. Quigley, Garrett, "Investing in International Small Company Stock," Institute for Fiduciary Education, July 8 2001.
  19. 30 Year Market Forecast - Portfolios Solutions LLC (2006). Reprinted with permission from Rick Ferri, CEO, Portfolio Solutions
  20. The Four Pillars of Investing - William Bernstein (2002), page 72