State Street study on ‘surprising’ small-cap performance


Smaller companies have disappointed since the global financial crisis, but they have still, slightly, outperformed large companies, at least in Australia. The disappointment comes from what is expected of smaller companies in rising markets.

A research note published last week by State Street Global Advisors (SSGA), poses the question: “The underperformance of the smaller companies may seem somewhat surprising. Don’t smaller companies usually outperform in up markets?”

While SSGA doesn’t say this: the long underperformance of value stocks compared with growth, both in Australia and globally, is also very unusual. These are unusual times. But with value stocks the tide may have turned. Small caps may do also.

Bruce Apted, SSGA head of portfolio management for Australian active quantitative equities, who wrote the research note, says underperformance by small caps during the GFC, from October 2007 to February 2009, was somewhat expected. The higher beta worked in reverse and combined with a risk-averse environment resulting in significant underperformance from smaller companies.

“The curse of a high-growth company is pain when the growth expectations are revised lower. Disappointing performance since the GFC was partly explained by disappointing earnings growth (from February 2009 to October 2019). What has been more surprising has been the more muted performance from the small companies since the GFC.

“Despite a period of above-average equity market returns the smaller companies index (S&P ASX Small Ordinaries Index) has lagged expectations generating only 12.0 per cent a year compared to 11.6 per cent a year for the larger companies index (S&P/ASX 100 Index).”

Since the GFC, the expected growth averaged 21 per cent but actual growth came in at only 9.3 per cent. Smaller companies have not lived up to the expectations of higher growth since the GFC, Apted says. Volatility has also been higher than the larger capitalised companies. In contrast, the S&P ASX 100 index has not had the same expectations for lofty growth but, equally, has been more consistent in delivery on that growth.

“Interestingly, in recent years the growth expectations (according to Thomson Reuters numbers and SSGA analyses) have been reduced, lowering the bar for beating expectations,” the research note says.

– G.B.