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Jay Kumar

Large caps outperform small caps over long-term

By Jay Kumar
4 minute read

An analysis of the performance of factors in the Australian share market reveals some very valuable insights for equity investors. One of the most interesting findings is that large capitalisation stocks have beaten small caps over all time periods except the past 12 months, contrary to the conventional wisdom that small cap returns beat larger companies’.

There are several different factors which drive equity returns. Company size refers to buying companies which are either large or small. “Value” investing involves buying stocks with low prices relative to their financial fundamentals such as earnings while “quality” companies are those with financially healthy balance sheets and strong returns on capital. “Momentum” investing involves buying companies with strong performance trends.

While most investor portfolios have exposure to one or more factors, the reality is that some factors tend to deliver better risk-reward than others over the longer-term in the Australian equity market.  Large-cap stocks fall into this category when compared to small caps.

Traditionally, it is believed that small caps outperform large caps because they are growing faster, a conclusion of much research, most famously that from academics Eugene Fama and Kenneth French. Their research found smaller companies outperformed larger ones over the longer-term, with investors being rewarded for the greater risk in backing more volatile smaller companies.

But our factor analysis reveals that over longer-term periods of 10 and 20 years, Australian large-cap stocks outperformed small caps convincingly, contrary to popular belief. The chart below highlights this outperformance over three, five, 10 and 20 years. That is a convincing outperformance.


1 year

3 year

5 year

10 year

20 year

Large cap






Small cap












Source: Foresight Analytics and Refinitiv. Data is to 30 June 2020. Returns are measured by the Foresight Large Cap universe and Foresight Small Cap universe, which are represented by the top 90 per cent market cap of companies in the Australian share market while the small caps are the bottom 10 per cent of market cap.

There are several reasons for this, but it has much to do with the concentration of the ASX 200 in large financial and mining stocks. Put simply, the weight of money has been directed to just a few big stocks, the big banks and miners. Investors’ money, both actively and passively managed, has piled into these big stocks. They include all the big four banks, BHP Billiton and Rio Tinto, healthcare giant CSL and telco giant Telstra. This has entrenched the gains of large caps over small caps over the longer-term.

Over the shorter periods, the story is not dissimilar. Foresight Analytics has examined the performance of factors over several stock market crisis periods. It is well known that money will flow to particular types of assets – most notably quality stocks – during a crisis, but we also have examined how large caps have performed versus small caps in Australia.

What we found is that large caps consistently outperformed small caps across all major financial market crises. This is exactly what happened in the first month of the COVID-19 crisis, though small caps rebounded strongly after the first 30 days of the crisis. The COVID-19 pandemic resulted in large-cap, quality and growth factors delivering significant positive premiums. The impact of the pandemic on factor returns has been much more severe (in speed and depth) than the previous major crises, particularly during the first 30 days. As a result, the coronavirus pandemic provided opportunities for generating alpha from managing factor exposure or pursuing factor rotation strategy.

However, unlike previous crises, the value factor has underperformed growth while aggressive asset growth beat conservative asset growth. In addition, after a significant underperformance from small caps, we witnessed a strong recovery after the first 30 days. Momentum and quality premiums witnessed significant volatility after first 30 days of the current crisis as well, as the chart below shows.

Given the pattern of the large-cap factor performance behaviour during the previous three crises, investors can reasonably expect the large caps to outperform during future stock market crises.

Factor investing is often captured by active fund managers investing in assets with particular attributes such as value stocks or small caps, or “smart beta” ETFs that track a rules-based index. For investors, it is important to understand how factors work when evaluating your investment’s performance and making any decisions to hire or fire a manager or invest in a particular investment product. Some factors give better risk-adjusted returns than others. And despite the rhetoric from some investors, backing smaller riskier stocks in the Australian share market won’t necessarily give better returns than backing larger, less volatile stocks. Our share market is just too concentrated for that.

Additionally, investors can manage the negative drag from size factor by avoiding passive and smart beta strategies that seek to just maximise exposure to the size factor without paying any regard to other fundamentals. Investors would be better served by selecting skilled small-cap active managers with proven track record of managing the size factor headwind while seeking to add value by picking fundamentally strong companies in the small-cap space.

Jay Kumar, founder & managing director, Foresight Analytics