Portfolio Design: A Modern Approach to Asset Allocation

RELATIVE PERFORMANCE OF LARGE-CAP AND SMALL-CAP STOCKS—BROADER ANALYSIS

A broader analysis of small-cap stocks confirms that there is a sizable small-cap premium for the longer sample period. This broader analysis draws on a data set developed by Fama and French using CRSP data. As part of their study of size and style effects on stock returns, Fama and French developed a data set dividing U.S. stocks by size in deciles and in quintiles. This chapter will analyze the quintile data in detail.15

Table 3.7 summarizes this data set. The methodology to divide stocks into deciles and quintiles is similar to that reported in the SBBI Yearbook discussed above.16 The quintiles are defined using NYSE stocks alone, then stocks from the NASDAQ and AMEX are added to each quintile. For that reason, Quintile 1 with the largest stocks has only 340 firms, but 77.2 percent of the market capitalization. In contrast, Quintile 5 with the smallest stocks has 2229 firms but only 1.9 percent of the capitalization.

Table 3.7 shows a systematic increase in returns as the average size of firms diminishes. The smallest firms have an average return that is 2.8 percent larger than the largest firms. But the firms in Quintiles 2, 3, and 4 also have sizable premiums over those of the largest firms. A similar set of findings is obtained if the stock market is broken up by deciles. In that case, all nine of the smaller deciles have substantial excess returns relative to Decile 1 which has the largest stocks.