Swedroe: Small Value Vs Midcap Value

July 28, 2014

Sometimes your choice of index is as important as which value-tilts you favor.

My column from July 14 on the persistence of the small-value premium resulted in some interesting discussions on the subject. I thought it would be informative to share one of them.

One reader pointed out that in the past 20 years, midcap value stocks had outperformed small-value stocks. For the period from July 1994 to June 2014, the Russell 2000 Value Index returned 11.04 percent while the Russell Midcap Value Index returned 12.47 percent. Thus, for that 20-year period, it looks like midcap value stocks outperformed small-cap value stocks by 1.43 percentage points per year.

Before taking a deeper look at the returns data, it’s important to note that, as with any factor, there’s a non-zero chance small value will provide a negative premium. This is true no matter what the factor or how long the horizon. Thus, while it would be an unexpected outcome, we shouldn’t be totally surprised if midcap value stocks did outperform small-value stocks over a 20-year period, or even a longer one. That’s one reason investors should diversify investments across factors and not concentrate all their eggs in a one-factor basket.

I was a bit surprised at the performance gap, so I thought it worthwhile to look at the evidence in more detail. For another point of comparison, I reviewed the returns for the Dimensional Fund Advisors Small-Cap Value Fund (DFSVX). (Full disclosure: My firm, Buckingham, recommends Dimensional funds in constructing client portfolios.)

I chose that fund because, since inception, it has done an exceptionally good job of tracking the benchmark Fama-French Small Value Index (ex-utilities). From April 1993 through May 2014, DFSVX returned 12.73 percent per year, virtually matching the performance of the Fama-French index and underperforming its benchmark by just 0.08 percentage points a year, despite an expense ratio of 0.52 percent.

While the Russell 2000 Value Index returned just 11.04 percent per year for the 20-year period in question—underperforming the Russell Midcap Value Index by 1.43 percentage points per year, as discussed earlier—DFSVX actually outperformed the Russell Midcap Value Index during this period by 0.5 percentage points per year, returning 12.97 percent. In other words, it isn’t that midcap value stocks outperformed small-value stocks over the period in question.