Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Why Australia has missed out on the “small cap effect”

Introduction

The idea that smaller companies offer higher risk-adjusted returns than larger companies, a claimed phenomenon known as the “small cap effect,” continues to live rent-free in the collective mind of Australian investors.

The size effect was first coined in Rolf W. Banz’s seminal 1981 paper “The relationship between return and market value of common stocks.” 1 Banz asserted that smaller firms, which he defined as the smallest 20% of the universe by market capitalisation, have higher risk adjusted returns, on average, than larger firms. Banz also found little difference in returns between medium sized and large sized firms.

But, for an investor, is the concept all it’s cracked up to be? Namely, does Banz’s concept of the small cap effect hold water in the Australian market?

There are currently 2,400 firms listed in the ASX. If an index was to be created on the ASX using Banz’s definition of a small firm, the largest constituent would be roughly A$8m in market capitalisation. In contrast, the smallest company in the ASX small ordinaries index currently is $200m in market capitalisation; and some of the largest constituents are larger than A$10b in market capitalisation. Perhaps unsurprisingly, the experience of an in investor in the ASX small ordinaries index has persistently bore no resemblance to the stellar returns depicted by Banz.

While many investors in Australia take a decision to structurally overweight small cap stocks given the sector and stock concentration in the large cap index, our analysis suggests that a separate allocation to small caps isn’t necessarily the best or most cost effective way to achieve this.

This paper will make the case that the performance, risk and constituent characteristics of the small cap index in Australia are poor; that the small cap designation is itself a misnomer (at least as it pertains to Australia); and the consequent benefit of investing in an unconstrained fund that can play the entire ASX.

Download the full paper

  •   13 June 2024
  • 1
  •      
  •   
banner

Most viewed in recent weeks

Little‑known government scheme can help retirees tap into $3 trillion of housing wealth

The Home Equity Access Scheme in Australia allows older homeowners to tap into their home equity for retirement income, yet remains underused due to lack of awareness and its perceived complexity.

Origins of the mislabeled capital gains tax ‘discount’

Debate over the CGT discount is intensifying amid concerns about intergenerational equity and housing affordability. This analysis shows that the 'discount' does not necessarily favor property investors.

2 billion reasons to fix retirement income

A proposal to address Australia's 'stranded balances' in retirement by requiring super funds to transition members to pension phase at 65, boosting retirement income and reframing super as a source of income.

The ultimate superannuation EOFY checklist 2026

Here is a checklist of 28 important issues you should address before June 30 to ensure your SMSF or other super fund is in order and that you are making the most of the strategies available.

Div 296 may mean your estate pays tax on assets your beneficiaries never receive

The new super tax, applying from 1 July, introduces more than just a higher rate on large balances. It brings into focus a misalignment between where wealth sits and where the tax on that wealth ultimately falls.

Do super funds need a massive wake up call?

UK retirement expert, Guy Opperman, believes super funds are failing at supporting members in deaccumulation. Here is what Australia should do about it. 

Latest Updates

Retirement

How inflation is quietly moving the goalposts on retirement

Inflation doesn’t just raise today’s bills - it quietly increases the amount needed to retire, while simultaneously making it harder to save. Three steps to take before June 30th to improve retirement outcomes.

Investment strategies

Three strategies for investing amid AI whiplash

AI fears have shifted from bubble talk to disruption anxiety, driving investors toward asset‑heavy, 'AI‑resistant' businesses while punishing many software and service firms. This environment may be ripe for stock pickers.

Investment strategies

Are private market assets the answer in an unstable world?

Private markets can offer diversification and return potential, but their opacity, scale and wide dispersion of outcomes make manager selection and due diligence critical for non‑institutional investors.

Property

Mispriced in plain site: The case for Global REITs

Global REITs have fallen out of favour, trading at deep discounts after years of underperformance, despite resilient earnings and improving fundamentals.

Investment strategies

Survival is the only success

True financial success isn’t about how much you make, but whether you can sustain it — survival is the only win that matters.

Investment strategies

$42 billion too late

Why Australia's biggest energy bet may already be redundant while a less celebrated government program is exceeding expectations. 

Investment strategies

Do investors accept lower returns from assets that make them feel good?

Assets that deliver emotional satisfaction tend to offer lower financial returns, as investors accept an “emotional yield” in place of performance which shapes how investors approach ESG and unpopular assets.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.