It is common to hear the advice that you should diversify a portfolio and have many investments, representing several asset classes, to take advantage of an optimal portfolio.
Two groups of assets that can be included in a diversified portfolio are small cap and large cap stocks. The reason for including both asset types is that they do not always perform exactly alike. There are times when one of the two performs well, compared to the other.
That has been the case in recent months as large capitalization stocks have been reaching all-time highs and the small capitalization stocks have lagged.
The Russell 2000 Index hit a record high in August of 2018. The index is made up of approximately 2,000 companies with market capitalizations below $10 billion. They have a median market value of $791 million.
This can include companies with a market capitalization of $2 billion to $10 billion, which would be considered a “mid-cap” company and companies that have a market capitalization below $2 billion; which are “small-cap” companies.
After the August high, the Russell 2000 index fell by 27.2 percent by December 2018. Through July 17, 2019, the index was up 15.4 percent, trailing both the Dow Jones Industrial Average (DJIA) and the S & P 500 Index. Both of these indexes are composed of large-cap companies.
As of August 3, 2019, the DJIA is up 15.05 percent, the S & P 500 Index is up 18.32 percent and the Russell 2000 is up 14.61 percent year-to-date.
Multiple Asset Classes
Modern Portfolio Theory postulates that a diverse portfolio, that can include both small and large-cap asset classes, can increase overall return while maintaining an acceptable level of risk.
The idea is to lower volatility over time. With foreign and emerging market asset classes and fixed income, along with large and small-cap stocks, there is greater diversification.
For many investors, the concept of diversification is more familiar than Modern Portfolio Theory, and they have allowed themselves to have some exposure to both large cap and small cap stocks. Whichever approach they have learned about, the end result of holding both asset classes should help on balance over last year and this year.
The capitalization of companies that fall into the large cap class include companies that have capitalizations of $10 billion or above. These are very large companies and often household names.
These large cap companies performed well during this year and have outperformed small and mid-cap companies in many cases.
Some analysts believe that the small cap sector is poised for a comeback. They say that many have bottomed out in their valuations and that a weakening dollar can be a stimulus for the sector.
The third quarter of 2019 should see small cap stocks regaining faster earnings-per-share growth compared to their large-cap counterparts, according to some analysts. That faster pace is predicted by analysts for 2020 as well.
The shift in the Federal Reserve’s approach to interest rates is anticipated to benefit small caps also.
While many factors can explain the superior performance of the large-cap sector, the best bet going forward is to talk to an advisor and create a portfolio that includes many asset classes.