Small cap stocks can move differently at different times than large cap stocks. If you look at the past 83 years, small caps have averaged 11.7% while large caps have averaged 9.6%.  But the cost for this greater return is heightened volatility. 

One reason we want to overweight small caps in a portfolio coming out of a recession is that they often move faster than much larger capitalization stocks. 

Why?

For starters, small caps are more flexible as they can cut back or expand quicker in addition to not carrying as much leverage. 

Basically when we are putting more money into small caps, it’s a beta play.  Beta is how quickly an investment moves versus an index.  On the way out of a recession we want something that moves faster; which small caps tend to do.

MAJOR PROBLEM:  In many portfolios of new clients that we review and in most 401k plans we see severe weakness in terms of small cap exposure.  In some 401k plans, a small cap option isn’t even available. 

A poor choice in our opinion. 

But it does take more work to seek out quality small cap portfolios because an ideal portfolio would be one that doesn’t have a huge amount assets because liquidity and trading volume are issues in this space.  You can’t put a billion dollars into a small company without detrimental consequences.

Small cap portfolios will also close their portfolios after they’ve reached a certain size but if you are already a shareholder in a small cap fund, this is a good thing.  You don’t want the fund continuing to take in more and more new money. 

Lesson of the Day:  Regardless if you are underweight or overweight, an investor would be wise to consistently maintain a slice of their portfolio allocated to small cap mutual funds simply due to the extra layer of diversification.

###

Work with us:  Manarin Investment Counsel