Navigating the investment landscape can be quite daunting, especially when faced with decisions like whether to invest in small cap or large cap shares.
This question pops up often, and it’s crucial to have a clear understanding of the implications. In this article we look at the difference between the two using insights drawn from notable past studies, along with current market trends.
Caps – a term you often hear in investment circles – is an abbreviation of ‘market capitalisation’. Small-cap shares refer to shares of companies with a market capitalisation typically ranging between two to 10 billion dollars. This definition finds its roots in a study conducted back in 1992 by Fama and French.
However, it’s important to note that these benchmarks may vary depending on the region. For instance, in Australia, the bar for small caps tends to be set lower.
Historically, small-cap shares had a reputation of being the high performers, often outperforming their large-cap counterparts. But why was this the case? The reason lies in their inherent characteristics. Small caps are usually less liquid, meaning they are not as readily tradeable, and have more volatility. High volatility means that the price of the asset can change dramatically over a short period in either direction.
So, small caps, being highly volatile, could give you hefty returns during market highs but can also lead to substantial losses during market lows. The potential for higher returns with small caps was often seen as a reward for the greater risk investors took on.
But as we dive into more recent market trends, it appears this narrative has shifted. In the last few decades, large-cap shares in the United States and Australia have been giving small caps a run for their money, delivering equal, if not superior, performance.
Many companies that were once classified as small caps have grown significantly and are now considered large caps. Names that probably ring a bell, like Amazon, Microsoft and Apple, started off as small caps and have now evolved into large-cap corporations, significantly influencing the broader share market returns.
“The potential for higher returns with small caps was often seen as a reward for the greater risk investors took on
This shift paints a new picture, where the consistent outperformance of small-cap shares, observed prior to the 1992 study, no longer holds true. Over the past 20 to 30 years, investing in large-cap shares would have been a more profitable move.
Despite the perceived higher risk associated with small-caps, they have failed to deliver superior returns consistently.
Now, if your heart is still set on small-cap shares, there’s good news. Stockspot recommends considering exchange traded funds (ETFs).
What’s an ETF? It’s like a basket filled with a variety of shares, representing different companies. It’s a great way to invest in a diverse range of small-cap companies at once, which helps spread out and manage your risk.
From a long-term perspective, the recommendation from Stockspot is to consider an ASX 300 ETF. The ASX 300 ETF is predominantly made up of large-cap companies, providing a stable foundation for your portfolio. Sprinkling in a few small-cap shares could add that pinch of diversity to your investment mix, without substantially ramping up the risk factor.
In conclusion, whether you lean towards small-cap or large-cap shares largely hinges on your personal comfort with risk and your long-term investment goals.