Why Small Cap Stocks Don't Outperform Like They Used to

We're talking about the small cap space or micro cap, but really we're talking about small cap investing, especially through that of an ETF.

Um, historically, when you think about ETFs, it's about allocation tools.

It's about gaining access to a market.

Historically, small cap has provided outperformance over full market cycles because you're taking more risk, right?

Um, but there's been a big dynamic shift over the last 30 to 40 years.

Um, and the idea that small caps used to pick up a whole lot of new IPOs.

You know, we used to get four or 500 IPOs a year before 2000.

And those IPOs would come to market.

They'd come in as small companies.

They'd enter the small cap indexes.

They'd slowly grow.

You'd get that price appreciation.

And you'd repeat, you rinse, and you'd get that uh resetting of the small cap um opportunity set, and you're taking more risk, getting more return.

Since the tech bubble and then again the financial crisis, there's been regulation changes. is there's been a dynamic shift um in terms of how soon mar these companies come to market, how easy it has come to market.

And we've seen a plummeting in new IPOs year-over-year, you know, um where we used to have 400 plus prior to 2000, now you're seeing less than 200 and some years less than 100.

And another big dynamic is that is that we've had this big boom in kind of private equity funding which has led to this issuance of what we call unicorns.

There's companies that are coming to market now, the big IPOs are skipping right past small cap and in most case right past midcap and going right into large cap indexes and you're missing that whole opportunity set.

So all that kind of sets me up to to encourage your audience to think about small cap a little bit different than it used to be.

Um now if you're going to outperform, I still believe in small cap.

I actually think that adding that risk and will get you longer term outperformance over time.

It's just a math game. you're going to get a little higher beta, a little higher return.

But I think you got to strategically think about doing it where you're either applying a really good screen set or actively managing in this space because it's not just a, hey, I'm going to pick up these IPOs and outperform and get that growth.

You're you really need to find, hey, this is a company like in the industrial sector or in the material sector that's always going to be a small cap.

They're they have a limited marketplace and sometimes they're going to be overvalued and other times undervalued.

I want somebody picking that subset of the market and either doing a really good screening job or um you know actively managing it.

So I would encourage folks in this space to look at some of the traditional big shop active managers that are known for their small cap investing.

I won't go you know the T-Rose of the world, the John Hancocks, the Capital Groups um that can actually do a bottom up fundamental analysis.

I think in this area of the market that can add value and it's worth paying 20 30 extra basis points to get that opportunity set because that dynamic has just fundamentally changed and I don't see it reversing anytime in the future.

Hopefully not before I retire because that it just doesn't look like it's in the case.

So,