Big is beautiful, so the mantra goes. But not so in the stock market. The very long-term view of stock market performance by size of company, comparing small-caps to large-caps, reveals small-cap companies have in general outperformed the broad market quite substantially.
If you had invested £100 in the UK stock market back at the beginning of 1975, and had diligently re-invested all dividends (ignoring all taxes), then you would have today an investment worth well over £15,000 (Figure 1). Very impressive, you might say to yourself.
Figure 1: Small-Caps Have Done Far, Far Better than Large-Caps
Source: Author, FTSE, Datastream, Hoare Govett
If, however, you had instead invested that £100 in an index of UK small-cap stocks in January 1975 on the same basis, you would now have an investment worth nearly £55,000.
In other words, over the very long-term (nearly 40 years) the small-cap segment of the market has delivered three-and-a-half times the performance of the overall stock market, which is dominated by very well-known stock market giants such as BP, Vodafone and HSBC.
Why would this be the case? The simple explanation is that smaller companies by and large tend to be younger companies with more innovative products or services and which can post faster growth rates, rather than massive companies that are well-established in mature markets with long-running products or services, and which therefore tend to grow at a more sedate pace.
The January small-cap effect
Not only have small-cap stocks done considerably better than large-caps over the long-term in the UK and US, a fact well-documented in the academic financial market literature, but these pint-sized gems have over time performed particularly well at the beginning of the year, the so-called January small-cap effect (Figure 2).
Figure 2: Spot the Small-Cap January Effect!
Source: Author, FTSE, Datastream, Hoare Govett
While this effect was originally identified in US small-cap stocks, UK small-caps exhibit exactly the same tendency to outperform in January, historically averaging over 4% gains in January since 1975.
In fact, in the UK the first four months of the year have been the best historic period of performance, delivering an average of over 13% from January to April.
