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business newsWhy There Are No Big Differences Between Large- and Small-Caps
The Russell 1000-Russell 2000 spread has converged over time.
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The noble idea behind all of this is size matters; as a stock’s capitalization increases, it becomes harder and harder to hit the proverbial 10-bagger. Sometimes even laying down a halfway decent sacrifice bunt can be a chore: The average annual total returns on Microsoft (MSFT) and Intel (INTC) over the past 10 years have been 0.815% and -2.04%, respectively.
Convergent Returns
If you throw a rock down Wall Street, you might hit someone, perhaps amongst the Occupiers themselves, issuing a forecast for the relative performance of large-capitalization versus small-capitalization stocks as measured by the Russell 1000 and Russell 2000 indices, respectively, and ETFs such as the iShares Russell 1000 (IWB) and iShares Russell 2000 (IWM), also respectively.
This might be a very good use for a rock: If we compare the total return paths for the indices since May 1995, we find they had one period of divergence, the late-1990s bull market, and that is it. Once that boom busted, returns converged for the next boom-bust-boom-semi-bust cycle. At the end of more than 16.5 years, all you have to show before taxes, inflation and expenses is an incremental return of 2.88% in favor of the Russell 2000. That is average annual outperformance of 0.175%...and did I mention the Russell 2000 has a higher standard deviation of returns?
Differential Implied Volatility
Not only does the Russell 2000 have a higher historic volatility, option traders give it a higher implied volatility as well. If we map the implied volatilities of the IWB and IWM since October 2000, we find only one period, the dot-com bust, when IWB volatility was higher for any protracted period of time. This period coincided with the large-capitalization large-scale decapitation, particularly in the tech sector.
Is this constancy of relative performance and volatility reason for despair? No; first of all, if you have not despaired by now, you are not going to do so. Second, take heart your selection of U.S. equities is unlikely to be a gamble based on capitalization. It is simply one less source for error.
My own solution is to expose yourself to both capitalization classes at once, in a vehicle such as the IWV ETF based on the broad Russell 3000 index, the combination of the Russell 1000 and Russell 2000 indices. (Do these folks make the math easy, or what?) A long-term investor should have an allocation to U.S. equities, period, and if you want to despair over size not mattering, I will not stop you.
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