Smaller companies (small caps) are typically defined as the lowest tier of quoted companies by market capitalisation. The definitive market value of such companies varies considerably,depending on many factors including the overall size of the regional market, but the small cap tier would typically represent the bottom 3-10% of a market. Most of the major index providers, such as MSCI, Russell and FTSE, have long-established small cap indices which are used as broad benchmarks for small cap portfolio managers. Many small caps may be characterised as small in stock market terms, while actually being very large and long-standing businesses within their industries. For example, Tenneco, quoted in the US, is a constituent of small cap indices and yet is one of the world’s leading global automotive suppliers with 22,000 employees worldwide and 80 manufacturing facilities across six continents generating revenues of almost USD 6 billion a year.
It is widely accepted that small cap stocks perform better over the longer term. There have been many academic studies conducted on the size effect. Pioneering work by Dimson and Marsh in the UK as shown in figure 1 highlights the substantial long-term premium experienced by small cap investors. The RBS Hoare Govett Small Cap (HGSC) Index measures performance of the smallest 10% of listed UK companies by market value. Over a unique 57-year history, the data suggest a small cap premium of +2.5% per annum over large cap; a very meaningful amount when compounded over such a period.”