Wall Street and big investors are showing a little more love for small-cap stocks

  • By Nicholas Jasinski,
  • Barron's
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Small-cap stocks have outperformed large-caps over the past decade, and Wall Street and its institutional clients are paying more attention to the asset class than they used to. According to research by Eduardo Lecubarri, global head of small- and mid-cap equity strategy at JPMorgan , small-caps have seen both their analyst coverage and portfolio weights rise in recent years.

The small-cap Russell 2000 index (.RUT) has climbed 255% since 2009, 11 percentage points ahead of the S&P 500 (.SPX). Meanwhile, the percentage of assets under management invested in small- and midcap stocks in U.S. large- and all-cap funds has doubled since 2007. The shares now represent almost 20% of those institutional investors’ assets.

And while mid-, large-, and megacaps have all seen a decrease in the average number of brokers’ research departments that cover them since 2016, small-cap coverage in the U.S. actually went up in that time period. But the average small-cap still has only 4.4 analysts who research it, compared with 23.2 for megacaps.

“Coverage tends to drive liquidity,” Lecubarri wrote in a recent report. “With an increase in coverage usually being followed by an increase in the number of shares traded.”

That could partially explain institutional investors’ willingness to devote a larger part of their assets to smaller companies. But the characteristics of small-caps have also just made them more attractive investments over the past decade. Today, Lecubarri cites small-caps’ better relative growth prospects than large-caps’ in a slow-growth environment and their reduced exposure to trade wars and protectionist political sentiment.

Large-cap active fund managers have also faced rising pressure from investors’ increasing preference for passive investment strategies over the past decade. The search for ways to differentiate their portfolios and improve returns led them to increase their weighting to faster-growing—and under-the-radar—small-caps. Lecubarri estimates that small-caps’ current liquidity is sufficient to accommodate another doubling in institutional investors’ assets under management devoted to them.

The shift in coverage toward small-caps illustrates a larger change in the research industry’s priorities. In all market-cap ranges, the companies that had the most analysts following them three years ago have seen the biggest drop in coverage.

“This to us just makes sense as sell-side research departments strive to boost the value added by their research, moving away from ‘maintenance’ research on widely covered companies,” wrote Lecubarri.

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