Long-term investors who are more likely to shake off short-term swings should take a look at small-cap value stocks and related exchange traded funds for potentially better returns.
Many market observers have extolled the long-term benefits of small-cap stocks, and going one step further, the small-cap value category could provide even better returns, writes Sheyna Steiner for Bankrate.
ETF investors can also target small-cap value plays through options like the Vanguard Small-Cap Value ETF (NYSEArca: VBR), iShares S&P Small Cap 600 Value Index (NYSEArca: IJS) and iShares Russell 2000 Value Index (NYSEArca: IWN). [Interested in the U.S.? Look to ETFs that Target Smaller Companies.]
Over the past 10 years, VBR has generated an average annual return of 8.1%, IJS returned an average 7.9% and IWN provided 6.4%. In contrast, the S&P 500 index returned an average 7.7%.
The small-cap segment includes businesses worth $400 million to $1.8 billion. Additionally, the value style refers to the earnings of the company relative to stock prices, and value stocks typically have lower price-to-earnings ratios, or the price of the stock is cheap relative to earnings.
While excess returns for an asset category typically diminish if more people know about, outperformance in small-cap value has persisted. Observers attribute the outperformance to factors and risks, along with investment behaviors.
Factors such as size, value and profitability or quality all contribute to the value style. Additionally, potential rewards are associated with the relative risks an investor will take.
“Eugene Fama and Kenneth French called them ‘risk premiums.’ It’s the factors and your exposure to them that explain the vast majority of the differences in risks and returns of a portfolio,” Larry Swedroe, director of research for Buckingham Asset Management and the BAM Alliance, said in the article.
Investor behavior will also affect the investment. For instance, growth stocks typically hold the limelight as they are faster moving and are likely to grab more attention. On the other hand, this leaves less demand for the value play.
“Small growth might be a biotechnology company or biomedical research. People like to talk about them at parties. The behavioral preference is that ‘I want to overweight the GenTechs of the world,’ which would be giving rise to the outperformance of value stocks,” John B. McDermott, associate professor of finance at the Dolan School of Business at Fairfield University, said in the article.
Moreover, small-cap value stocks could provide better risk-adjusted returns. Swedroe pointed out that portfolios with exposure to small-cap value stocks were less volatile than the S&P 500 and returns were also better than the large-cap benchmark for the period between 1970 through 2013.
For more information on small-capitalization stocks, visit our small-cap category.
Max Chen contributed to this article.