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Asset Management Viewpoints: Time for Small Caps

By Thomas O. Herrick
Chief Investment Officer, Managing Director

Within the context of a diversified equity portfolio, we recommend long-term exposure to small capitalization companies. Comparing the Russell 2000 (small cap) and Russell 1000 (large cap) indexes we note the following data regarding a massive dispersion between small caps and larger companies. Current earnings multiples in small caps suggest 11% annualized returns over the next 10 years vs 5% annualized returns for large caps. That conclusion is based on historical regression of price to earnings multiples versus subsequent returns. The relative forward price/earnings (P/E) multiple of the Russell 2000 vs Russell 1000 also suggests that small caps could outperform large caps over the next ten years.

Graph shows cap comparisons where small caps remain historically cheap vs. large caps.
Source: BofA US Equity & Quant Strategy, FactSet

Graph shows cap comparisons where mid-caps trade at a near record premium to small caps.
Source: BofA US Equity & Quant Strategy, FactSet


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