Has The Small-Cap Premium Disappeared?

October 07, 2013

Annual Average Returns (%)

1927-1962 1963-1990 1991-2012 1927-2012
CRSP 1-5 (A) 11.86 11.34 11.08 11.49
CRSP 6-10 (B) 16.42 15.58 14.88 15.75
SmB Research Factor 2.93 3.37 2.95 3.08


You'll note that small stocks outperformed in all four periods. For information purposes, the table below shows the Sharpe ratio (a measure of risk-adjusted returns). The Sharpe ratio is calculated by taking the average annual return of the asset class and subtracting from it the annual average return on one-month Treasury bills (the riskless instrument) and dividing the result by the annual standard deviation of the asset class.

Sharpe Ratio

1927-1962 1963-1990 1991-2012 1927-2012
CRSP 1-5 (A) .448 .281 .419 .396
CRSP 6-10 (B) .407 .318 .505 .396


For the full 86-year period, small and large stocks provided identical risk-adjusted returns. However, you'll note that even though Fama and French never claimed that small stocks provided higher risk-adjusted returns—yet they did clearly state that they believe the higher returns are compensation for risk—in fact, small stocks did provide higher risk-adjusted returns during the period they looked at, and have also done so in the post-study period.

No matter how we have looked at it, the data clearly show that small stocks have provided higher returns over the long term, as well as in the post-1990 era. In other words, there has been a size premium.

By looking at the data from international markets, we can see out-of-sample evidence on the size factor.

The International Evidence

Dimensional Fund Advisors created an international small-stock index with data beginning in 1970. For the period 1970-2012, international small stocks outperformed international large stocks by 4.66 percent per year, returning 14.40 percent per year versus 9.74 percent per year for the MSCI EAFE Index.

Fama and French also provide us with another out-of-sample test with evidence from the emerging markets. For the period 1989-2012, the Fama-French Emerging Market Small Cap Index returned 13.44 percent per year, outperforming the 12.29 percent per year return of the large-cap Fama-French Emerging Markets Index by 1.15 percentage points per year.

In the next installment, we'll turn to the issue of whether the publication of the findings or outperformance automatically leads to the disappearance of a premium.

Larry Swedroe is director of Research for the BAM Alliance, which is part of St. Louis-based Buckingham Asset Management.


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