A Wider Net on Premiums
Even the most patient angler can get frustrated when the fish are refusing to take the bait. Likewise, investors can lose patience when a desired premium doesn’t turn up for years on end. The answer in both cases is to cast one’s net as widely as possible.
I was thinking about this lesson in the context of small cap value performance. Many investors have expressed concern over small cap value stocks underperforming large caps in the US over the 20 years ending in February. Two decades is a long time for an expected premium not to show up, and investor frustration is understandable.
But there are a couple of points to make here. Firstly, this long period of small value trailing large caps is most noticeable in the US and is largely an outlier from a global perspective. In major non-US markets, by contrast, small caps have outperformed large caps over the same period.
Secondly, we know that predicting when and where positive size, value and profitability premiums will appear next is a tough ask. The record shows that the realised volatility of these premiums at the country level has been higher than when considering all countries together.
Like an angler who fishes in more than one spot, the answer is global diversification. Spreading your investments across many countries is an effective tool both in managing idiosyncratic country risk and ensuring you capture positive premiums where and when they occur.
This can help you stay on track with your long-term goals through all kinds of markets.
Casting a Wider Net
20-Year Annualised Return Difference between Small Cap Value Stocks and Large Cap Stocks, as of 29 February 2024
This article originally appeared in Short N Sweet, a newsletter for Dimensional clients.
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Dimensional US Small Cap Value Index was created by Dimensional in March 2007 and is compiled by Dimensional. It represents a market-capitalisation-weighted index of securities of the smallest US companies whose market capitalisation falls in the lowest 8% of the total market capitalisation and whose relative price is in the bottom 35% of the eligible market, or 25% prior to January 1975, after the exclusion of utilities, companies lacking financial data, and companies with negative relative price. The eligible market is composed of securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market. Exclusions: non-US companies, REITs, UITs, and investment companies. From January 1975, the index excludes companies with the lowest profitability and highest relative price within the small cap universe. The index also excludes those companies with the highest asset growth within the small cap universe. Profitability is measured as operating income before depreciation and amortisation minus interest expense scaled by book. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Source: CRSP and Compustat. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in December 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional International Small Cap Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents, after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortisation minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Exclusions: REITs and Investment Companies. Prior to January 1990: Includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalisation conditional on the securities being in the bottom 10% of market capitalisation, excluding the bottom 1%. All securities are market capitalisation weighted. Each country is capped at 50%. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Emerging Markets Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortisation minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Maximum index weight of any one company is capped at 5%. Exclusions: REITs and investment companies. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Europe Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortisation minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. Prior to January 1990: Dimensional UK Small Value Index and Dimensional Europe ex UK Small Value Index combined using small value country weights. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Asia Pacific Small Cap Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents, after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortisation minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. Prior to January 1990: Includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalisation conditional on the securities being in the bottom 10% of market capitalisation, excluding the bottom 1%. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Canada Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies whose relative price is in the bottom 35% of constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortisation minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
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