Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 371

Australian large caps outperform small caps over long term

An analysis of the performance of factors in the Australian share market reveals some valuable insights for equity investors. Contrary to conventional wisdom, large capitalisation stocks have consistently beaten small-cap companies.

While most investor portfolios have exposure to one or more factors, some factors tend to deliver better risk-adjusted returns than others over the longer term. Traditionally, it is believed that small caps outperform large caps because they are growing faster, a conclusion most famously promoted by academics Eugene Fama and Kenneth French. Their research found investors were rewarded for the greater risk in backing more volatile smaller companies.

A challenge to conventional wisdom

But our factor analysis reveals that over longer-term periods of 10 and 20 years, Australian large cap stocks outperformed small caps convincingly, as shown below to 30 June 2020.

Source: Foresight Analytics and Refinitiv. Returns are measured by the Foresight Large Cap universe and Foresight Small Cap universe, which are represented by the top 90% market cap of companies in the Australian share market while the small caps are the bottom 10% of market cap.

The main reason is the concentration of the ASX200, where the weight of money, active and passive, has been directed to a few large offshore earners, the big banks, miners and healthcare. Example include miners BHP Billiton, Rio Tinto and Newcrest; financials Commonwealth Bank, Westpac and ANZ; healthcare names CSL, Sonic and Ramsay; IT heavyweights Computershare, REA and Carsales. This has entrenched the gains of large caps over small caps over the longer term.

Top performing sectors within large cap world

Within the large cap world, some sectors stand out in consistently delivering high returns over the past decade, such as healthcare, industrials, technology, consumer cyclicals and financials. The laggards over the past decade include energy, utilities and telecom.

Note: Returns are as at 30 June 2020. Thomson Reuters Business Classification (TRBC) is used for industry sectors.
Data source: Foresight Analytics Global Investment Database

High-performing stocks from the mining industry have been boosted lately by gold’s stellar performance and an uptick in other commodity prices such as iron ore. Large cap consumer non-cyclical stocks are well represented by Domino’s Pizza, whose fortunes are continuing to rise with more eating at home due to COVID-19 restrictions.

Size performance over the short term

Over the shorter periods, the story is not dissimilar and large caps outperform. Money tends to flow into particular types of assets – most notably quality stocks – during a crisis, but we found that large caps consistently outperformed small caps across all major financial market crises.

This is exactly what happened in the first month of the COVID-19 crisis, though small caps rebounded strongly after the first 30 days of the crisis. The COVID-19 pandemic resulted in large cap, quality and growth factors delivering significant positive premiums. The impact of the pandemic on factor returns has been much more severe (in speed and depth) than the previous major crises, particularly during in the first 30 days. As a result, the coronavirus pandemic provided opportunities for generating alpha from managing factor exposure or pursuing factor rotation strategy.

However, unlike previous crisis, the value factor has underperformed growth while aggressive asset growth beat conservative asset growth. In addition, after a significant underperformance from small caps, we witnessed a strong recovery after the first 30 days. Momentum and quality premiums witnessed significant volatility after first 30 days of the current crisis as well, as the chart below shows.

Initial impact of COVID-19 crisis more severe than previous crises

Given the pattern of the large cap performance behaviour during the previous three crises, investors can reasonably expect the large caps to outperform during future stock market crises.

Factor investing is often captured by active fund managers investing in assets with particular attributes such as value stocks or small caps, or ‘smart beta’ ETFs that track a rules-based index. For investors, it is important to understand how factors work when evaluating your investment’s performance and making any decisions to hire or fire a manager or invest in a particular investment product. Some factors give better risk-adjusted returns than others.

Despite the rhetoric from some investors, backing smaller, riskier stocks in the Australian share market will not necessarily give better returns than backing larger, less volatile stocks. Our share market is too concentrated for that.

Additionally, investors can manage the negative drag from size factor by avoiding passive and smart beta strategies that seek to maximise exposure to the size factor without paying any regard to other fundamentals. Investors would be better served by selecting skilled small cap active managers seeking to add value by picking fundamentally strong companies.

 

Jay Kumar is Founder and Managing Director at Foresight Analytics. This article contains general information only and does not consider your personal circumstances.

 

RELATED ARTICLES

Where do sustainable returns come from?

A better way to measure Australian small caps

Four big ideas in the small cap space

banner

Most viewed in recent weeks

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.

Latest Updates

Superannuation

Superannuation: a 30+ year journey but now stop fiddling

Few people have been closer to superannuation policy over the years than Noel Whittaker, especially when he established his eponymous financial planning business. He takes us on a quick guided tour.

Survey: share your retirement experiences

All Baby Boomers are now over 55 and many are either in retirement or thinking about a transition from work. But what is retirement like? Is it the golden years or a drag? Do you have tips for making the most of it?

Interviews

Time for value as ‘promise generators’ fail to deliver

A $28 billion global manager still sees far more potential in value than growth stocks, believes energy stocks are undervalued including an Australian company, and describes the need for resilience in investing.

Superannuation

Paul Keating's long-term plans for super and imputation

Paul Keating not only designed compulsory superannuation but in the 30 years since its introduction, he has maintained the rage. Here are highlights of three articles on SG's origins and two more recent interviews.

Fixed interest

On interest rates and credit, do you feel the need for speed?

Central bank support for credit and equity markets is reversing, which has led to wider spreads and higher rates. But what does that mean and is it time to jump at higher rates or do they have some way to go?

Investment strategies

Death notices for the 60/40 portfolio are premature

Pundits have once again declared the death of the 60% stock/40% bond portfolio amid sharp declines in both stock and bond prices. Based on history, balanced portfolios are apt to prove the naysayers wrong, again.

Exchange traded products

ETFs and the eight biggest worries in index investing

Both passive investing and ETFs have withstood criticism as their popularity has grown. They have been blamed for causing bubbles, distorting the market, and concentrating share ownership. Are any of these criticisms valid?

Sponsors

Alliances

© 2022 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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.

Website Development by Master Publisher.