Active Or Passive In Small Caps?

November 08, 2013

Indexation has created market inefficiencies in smaller U.S. companies, says Neuberger Berman.

[This article previously appeared on our sister site,]


According to asset manager Neuberger Berman, rising inefficiencies mean it's time for stock pickers to make a comeback in the US small companies market. But proponents of indexing say investors can choose alternative benchmarks to exploit any such biases.

The small-cap stock segment has traditionally been an area of rich pickings for active managers. Smaller companies are typically less widely followed than their large-cap counterparts, offering outsized rewards to those willing to put work into researching individual firms.

But in recent years active managers have been falling down on the job. Data from research firm Morningstar show that stock pickers are doing worse in small caps than at any time for years.

Since the turn of the millennium, the percentage of active small-cap mutual funds beating the Russell 2000 index has been in steady decline.

The Russell 2000 consists of the smallest 2000 companies by market capitalisation from the broader Russell 3000 index, and is widely used as a benchmark for smaller US companies.


In the early 2000s over four-fifths of active small cap managers were able to beat the index (on a rolling five-year view), but now the figure is down to less than 40 percent, Morningstar records.

According to Neuberger Berman, which cites the Morningstar data in a recent research report, "Small-Cap Distortions: Is There Hope For Active Managers?", the steadily worsening performance of stock pickers has little to do with any rise in the efficiency of the small-cap market segment.

The number of analysts following smaller US companies has been stable since 2000, the company says, while sell-side research biases (which often present opportunities to investors) haven't changed.

Instead, Neuberger Berman puts the tough recent environment for stock picking down to two factors: the distorting influence of the Fed; and the growth of passive, index-tracking small-cap funds such as ETFs.




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