The Case for a 'Small' Portfolio
Take two hypothetical portfolios. One -- call it the Major Leaguers -- consists of the largest 10% of all the companies traded on the New York and American stock exchanges. The bluest of the blue chips.
The other -- call it the Minor Leaguers -- consists of the smallest 10%. Size in this case is determined by an investor's measure: market capitalization. That is what you get when you multiply a company's outstanding shares by each share's market value, and in ordinary times it is a pretty good proxy for other measures of size.
Now go back to 1963. Here is how the contest stacks up:
share price market value
Majors $44.94 $1.1 billion
Minors 5.24 4.6 million
Care to hazard a guess on how the two portfolios have done since then? Marc Reinganum, a professor at the University of Southern California's Graduate School of Business, knows the answer, at least through the end of 1982. And it is dramatic.
Over that 20-year period (with portfolios updated annually to make sure they still contained the biggest and smallest companies) the Major Leaguers' stock yielded an increased value of 370%. Counting both dividends and capital appreciation, a dollar invested in the Majors' portfolio was thus worth about $4.70 at the end of 1982.
The Minor Leaguers' stock, however went up a whopping 7,149%, yielding about $72.50 for every dollar invested.
Nor has Reinganum examined only the extremes. Looking at the top 10%, the bottom 10%, and every 10% group in between, he has found a consistent relationship. The larger a portfolio's average market value, the lower its rate of return.
There is, to be sure, a catch, and it is called risk. Between 1969 and 1974, for example, when the market was sinking like a stone, the small companies looked as if they were wearing concrete shoes. The Minor Leaguers lost 56% of their value while the Majors Leaguers dropped only 19%.
Still, risk by no means explains all the difference. Using the statistician's method of regression analysis, Reinganum figured out how the various stocks would have performed if their "betas" -- a measure by which financial analysts calculate risk -- had been the same. Again, the results were pretty conclusive. "A $10 million firm," he says, "would experience monthly returns nearly 1% greater than $100 million firms and 2% greater than $1 billion firms with identical betas."
None of this means that you can buy any old small-company stock, any more than George Steinbrenner would hire just any 18-year-old to pitch for the Yankees. But it does suggest a simple and not always accepted conclusion. Other things being equal, a diversified small company portfolio has a good chance of outperforming a diversified large company one. Provided, of course, that you can hang on for the full nine innings.
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