Catching Stardust: Finding Smaller Stocks That Can Shine

WHAT YOU NEED TO KNOW

Smaller stocks offer diversification benefits and investment opportunities that can’t be found in their larger brethren. But because large-cap stocks have been so popular for the last 10 years, many investors have missed out on the compelling stories and advantages smaller companies can provide. Our research aims to shine some light on the universe of smaller stocks by examining their perceived risks, performance drivers and return potential—particularly amid a recovery from the COVID-19 pandemic and recession. The time is right for investors to consider smaller investments that have the potential to sparkle.

What’s Behind the Small-Cap Malaise?

Performance patterns of smaller stocks can at times be difficult to explain, particularly over shorter time frames. Over the long run, however, smaller-capitalization stocks have delivered an annualized return of about 11%, outperforming their larger cohorts by at least 120 basis points a year on average. While that doesn’t sound like much of a difference, consider this: $100 invested in each of the three indices in 1926 would now be worth $2.3 million from small-cap, $1.8 million from SMID-cap and $0.7 million from large-cap.

But since 2008, market currents have shifted. Investment trends have favored larger-cap stocks, at least temporarily, while investors sought safety from the below-trend economic recovery following the global financial crisis (GFC), and now the COVID-19-induced recession. During market crises, investors tend to shun smaller stocks because they’re widely perceived as riskier than their larger peers. But they also tend to rebound strongly during recoveries (Display).

Past performance does not guarantee future results.
Cumulative returns used for all time periods shown
An investor cannot invest directly in an index, and index results are not indicative of the performance of any speciﬁc investment, including an AllianceBernstein fund. Indices do not include sales charges or operating expenses associated with an investment in a mutual fund, which would reduce total returns.
As of September 30, 2020.
Source: FTSE Russell and AB

Smaller Stocks Make Bigger Splashes

So why have large-caps been so popular over the last decade? Governmental policies, global quantitative easing, and even the rise of passive investing, have fueled large-cap gains. Today it’s as if the laws of physics have been suspended: the largest companies keep getting larger, like trees growing to the sky.

But the laws of physics aren’t simply suggestions—they are laws. For example, the largest animals in the jungle aren’t always the mightiest. Elephants are big and strong, capable of carrying 130 humans or up to 1.5 times their body weight. But the mighty ant can carry up to 5,000 times its body weight. Which offers the better long-term return: the big lumbering elephant or the tiny but relatively stronger ant? The largest targets are also easiest to take down. As we’ve seen in previous market bubbles, some of the elephants are eventually taken out by smaller, more nimble new products and competitors that undercut older business models and products.

Some of the largest US companies have made a pretty big splash year to date. For example, Amazon, one of the five largest companies in the S&P 500, has returned an incredible 70% through September 30, 2020. And by that day, the combined market cap of just Apple and Microsoft was $1.4 trillion greater than that of the entire Russell 2000 small-cap index (Display).

Current analysis does not guarantee future results.
As of September 30, 2020
Source: Bloomberg, FTSE Russell and AB

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

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