The company said that while it expects better than average returns from the mega cap businesses, which account for 42 per cent of the market capitalisation but only 6 per cent of the volume of businesses, it was important to open up the “opportunity set” by looking outside the largest 100 businesses.
“Smaller companies are fertile ground for finding greater inefficiencies in the equity market,” State Street Global Advisors (SSGA) said.
“There are 55 analysts providing Bloomberg with earnings estimates for Apple Inc, but only 16 analysts covering Waste Management Inc, the 246th largest company in the benchmark universe with a market cap of US$30 billion. The opportunities to find mispriced stocks are greater when fewer market participants are scrutinising them.”
Smaller companies could also benefit from the proposed reduction in regulation under the new US administration, SSGA said, serving to “level the playing field” for smaller businesses who have fewer resources to put towards lobbying for tax exemptions.
The company did, however, caution that transaction costs could present difficulties for investors when it came to smaller cap stocks.
“Selling one stock to buy another involves trading costs – not just explicit costs like brokerage or GST,” SSGA said.
“These costs are tiny compared with the potential market impact associated with trading if seeking to transact on a large amount of a small company.”
The company said it was important to weigh a company’s expected returns against the expected volatility implications of holding that stock net of the expected transaction cost.
“In today’s environment where breadth in portfolios helps to insulate against extreme outcomes from concentrated positions, investing beyond mega caps is an important ingredient in the pursuit of strong risk adjusted returns through active management,” the company said.
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