Research & Insights
Returns on Small Cap Growth Stocks, or Lack Thereof: What Risk Factor Exposures Can Tell Us
Abstract:
The small cap growth space has been noted for its under performance relative to other investment styles. Is there something inexplicable happening, or can this phenomenon be attributed to fundamental factor exposures?
This paper examines the historical performance of small cap growth stocks through the lens of the Fama-French three-factor model and the use of quantitative measures, such as the Sharpe ratio, seeking to shed light on why this investment style has historically given investors so little to cheer about. Through multi-factor regression analysis, we determine that the majority of small cap growth underperformance comes from the 'growthiest' of growth stocks in the index. We conclude with simulations that suggest that investors can enhance their US small cap growth risk-adjusted returns by employing strategies that seek to minimize or even eliminate exposure to the highest-growth quintile of the small cap growth universe.