Small Caps: More Than Just a Factor Premium

By: 

Saketh Reddy CFA, Research Analyst, Investment Strategy and Research

Kamal Gupta CFA FRM, Investment Strategist

Altaf Kassam CFA, Europe Head of Investment Strategy & Research

Small-cap equities have long been a subject of interest for investors seeking diversification and enhanced returns. While the “size premium” has been a central theme in this debate, the investment case for small caps extends far beyond this single factor.

This paper explores the multifaceted benefits of small-cap allocations within global portfolios, examining their evolving role in the market, their unique diversification properties, and the practical considerations of implementation. We argue that while implementation challenges exist, a balanced approach that considers the holistic portfolio context can unlock the significant strategic potential of small-cap investments.

Size Premium: Dead or Just Sleeping?

The size premium has historically been cyclical, with periods of both outperformance and underperformance. The investment case for small caps extends beyond the size premium, encompassing diversification and broader market access.

Why Small Caps? A Growing and Diverse Opportunity Set

The small-cap universe has grown significantly in size and economic influence, offering investors access to a much broader and more diverse opportunity set than that of large and mid caps. Small cap indices provide valuable sectoral and geographic diversification compared to large- and mid-cap indices, while also providing a counterbalance to the concentration risk found in the latter indices.

Small Caps in Global Portfolios and Implementation Considerations

Within a diversified portfolio, small caps can enhance portfolio characteristics while potentially reducing the frequency of severe drawdowns. Implementing small-cap approaches at scale requires careful consideration of implementation costs. A combined active, passive, and enhanced approach can balance alpha potential with implementation feasibility.

See SSGA blog for more details and to download PDF.

Originally posted on March 19, 2025

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