Small-cap value stocks winning, as Nobel laureate Fama predicted


Eugene Fama

Eugene Fama

Eugene Fama, best known for laying the groundwork for the efficient market hypothesis, has been awarded the 2013 Nobel Memorial Prize in Economics, along with two other Americans. Fama’s research documenting the long-term outperformance of small-cap value stocks has also driven investor interest in the asset class, which is beating the S&P 500 index this year.

In the 1970s, the University of Chicago finance professor proposed that asset prices accurately reflect all available information. The implication is that beating the market with active stock picking is extremely difficult.

Fama shared the Nobel with Robert Shiller and Lars Peter Hansen “for their empirical analysis of asset prices.” Notably, Shiller has published research on the growing field of behavioral finance that challenges some of the key tenets of the efficient market hypothesis.

Aside from his work on efficient markets, Fama along with Kenneth French designed the three-factor model, a popular method for measuring the risk and performance of equity portfolios. They added size and value factors to the existing capital asset pricing model (CAPM).

The pair’s research found that small-cap and value stocks with lower price-to-book ratios have outperformed the broader market over longer time periods. This has come to be known as the small-cap value premium. In other words, value tends to outperform growth over the long haul, while small beats large.

In an interesting coincidence, U.S. small-cap value stocks rose to new all-time highs on the same day Fama was awarded the Nobel. The iShares Russell 2000 Value ETF (IWN) climbed to a fresh record on Monday.

The small-cap value ETF has posted a total return of 24.3% this year as of Oct. 15, compared with 21.1% for the large-cap S&P 500, according to Morningstar. IWN has a 10-year annualized return of 8.5%, versus 7.1% for the S&P 500 index.

Looking back even further, data from Morningstar shows that from 1926 to 2011, small-cap value stocks have returned 13.9% while large-cap growth stocks returned have 8.7%.

Note that Covestor offers a small cap value portfolio from Twinleaf Management.

Chart: The Dividend Guy

Photo credit: University of Chicago Booth School of Business

DISCLAIMER:  The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance does not guarantee future results.

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John Spence
John Spence
John leads the editorial organization at Covestor, including the production, editing and distribution of content. He has extensive experience with creating high quality financial content and his work has appeared in several national newspapers and print publications, including The Wall Street Journal, Washington Post and the Chicago Tribune. Previously, he covered personal finance for MarketWatch.com and ETFtrends.com. In his early career, John was an editor for IndexFunds.com and IndexUniverse.com. From 2004 to 2011, he also wrote a weekly ETF Investing column for Dow Jones. He earned a BA from Middlebury College, and an MFA in Writing from the University of San Francisco.