Level 0 Investing & ETF Basics · Part 14/16
Small Cap Value: A Factor Premium With Long Dry Spells
Two of the most thoroughly researched return factors are size (small companies) and value (cheaply valued companies). Combined as “Small Cap Value”, they are usually used as an addition to a broad core.
The funds in the catalog with their current holdings:
- iShares MSCI World Small Cap: the small-cap segment of the world index
- iShares Edge MSCI World Value Factor: the value tilt
Compared with the plain MSCI World, both hold far fewer large tech names and more industrials and financials.
The Limitation
The extra return measured in studies was very unevenly spread over time. Small Cap Value trailed the overall market for more than a decade, for example in the 2010s. Whether a factor premium will persist is disputed in the research.
What Counts as Small and Cheap
At MSCI, small caps are a country’s smallest companies that together make up about 14% of the free-float market value. Value is measured by ratios such as price-to-book. Small cap value is the overlap: small companies that are also cheaply valued.
Why a Premium Might Exist
Research offers two explanations. In one, small, cheap companies carry higher risks, for example in downturns or when raising money. Investors are paid for that with a higher expected return. In the other, investors systematically undervalue such firms out of habit or caution. Which explanation holds helps decide whether the premium persists.
Two Funds Do Not Make the Overlap
A small-cap ETF next to a value ETF does not add up to small cap value. The pair holds small companies of every valuation plus large cheap companies; the overlap is only part of it. The ETF overlap check shows how two funds overlap, and the portfolio X-ray shows the combined allocation of several funds.
What an Addition Means in a Portfolio
Adding small cap value means deliberately deviating from the overall market. That deviation, the tracking error, can run in the same direction for a decade. It is the price of a possible premium, and it cannot be calculated away in advance.
Information only, not investment advice.