Small Caps Have Done Better Than You Think

One of the most common questions I hear is, “What’s wrong with small caps?” This concern usually stems from relative returns over the past 10 years, during which US small caps underperformed the S&P 500 Index by a little over 4 percentage points. But which one of these asset classes has been behaving abnormally?

US small cap’s return over the last decade was within 1 percentage point of its average since 1927, at 11.01% versus 12.00%. The large cap S&P 500, on the other hand, was far from its long-run average. The index returned more than 15% over the last 10 years, nearly 50% more than its average since 1927 of 10.39%.

The S&P 500 has substantial weight in companies like the Magnificent 7, which have exceeded investor expectations with their earnings growth in recent years.¹ When investors are surprised in a good way, outsize returns may follow. That’s a windfall for investors with diversified portfolios. But expecting a continuation of large cap returns well in excess of the historical norm is betting on further unexpected success stories for these firms.

Many people have been searching for stories to explain US small cap underperformance. We’ve written previously about looking at the bigger picture with small cap returns and how some of the concerns over the current opportunity set may be overblown. But the stark contrast between short-term and long-term large cap returns suggests maybe investors are questioning the wrong segment of the market.

1. The Magnificent 7 stocks are represented by Alphabet, Apple, Amazon, Meta, Microsoft, NVIDIA, and Tesla. This information is intended for educational purposes and should not be considered a recommendation to buy or sell a particular security. Named securities may be held in accounts managed by Dimensional.

GLOSSARY

Annualized return:  The compound performance of an investment expressed on a per-year basis.

Relative return: A measure of the return of one investment relative to another.

Large cap: Refers to a company with a relatively large market capitalization.

Small cap: Refers to a company with a relatively small market capitalization.

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RISKS

Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.