The small-cap value asset class has also achieved better earnings growth and capital returns than other asset classes, including small-cap growth, large-cap value, and large-cap growth, while maintaining attractive valuations. In fact, small-cap value stocks have traded at depressed price-to-earnings ratios compared to those other asset classes for the better part of the past decade.
Looking ahead, there’s reason to believe in small-cap value stocks’ future potential, as well. Analyst coverage in this space is comparatively low. Nearly 85% of small-cap stocks are covered by fewer than 10 sell-side analysts, compared to 33% of mid-cap stocks and 6% of large-cap names.
This lower volume of research and coverage of the space gives active managers greater ability to seek out potential “hidden gems” among smaller companies and generate positive excess return. Historically, active managers have maintained an edge in small-cap investing. On a 10-year basis, the median small-cap manager has notably outperformed US small-cap equities, proxied by the Russell 2000 Index, by 0.94% on average, in 71% of the trailing periods.
Why small-cap value now?
We think now may be a good time to revisit small-cap value allocations, as our favorable long-term view is paired with depressed valuation levels, creating a potentially attractive entry point for the asset class.
Historically, small-cap value stocks have outperformed small-cap growth over the forward 10-year period when growth has beaten value over the trailing 10-year period (Figure 3). As illustrated in the top left quadrant of Figure 3, through the end of 2021, historically, value has always outperformed in the 10 years following a 10-year period of growth outperformance. Right now, we’re at the end of a 10-year period of growth outperformance, which suggests that the tide may turn, and we could be entering a period of value strength.