Twenty years ago, there were 7,355 stocks according to the Center for Research in Security Prices at the University of Chicago’s Booth School of Business. Currently, there are 3,600.
Twenty years ago, there were over 4,000 very small companies (microcap) that did not qualify for the Russell 2000 – a commonly used index of small company stocks ranked 1,001 – 3,000 by total market value. Instead of 4,000, the number today has dwindled to less than 1,000.
Historically, small companies have offered greater returns than larger ones but with additional volatility. Perhaps this history is in jeopardy. With venture capital firms investing in start-ups and allowing them to stay private longer instead of going public, add the red tape to become a public company and buyouts from larger companies, the supply continues to decline.
There may be several consequences to the decline of small stocks:
- Speculation that one reason many active mutual funds managers (selecting specific stocks) have performed poorly is the absence of a larger pool of small companies. The companies left in the market are larger and information is readily available – not so with smaller firms.
- If indeed smaller companies no longer outperform larger ones, it will change the way investors design their asset allocation.
Approximately 10% of the US stock market is comprised of small stocks and our portfolios have an allocation to this asset class. Should the numbers start showing the risk/return ratio from past decades no longer exists, why allocate to this group? It is something we are watching.