Small-cap Value Stocks Winning, As Nobel Laureate Fama Predicted

By John Spence
Eugene Fama

Eugene Fama

Eugene Fama, best known for laying the groundwork for the efficient market hypothesis, has been awarded the 2013 Nobel Memorial Prize in Economics, along with two other Americans. Fama's research documenting the long-term outperformance of small-cap value stocks has also driven investor interest in the asset class, which is beating the S&P 500 index this year.

In the 1970s, the University of Chicago finance professor proposed that asset pricesaaccurately reflect all available information. The implication is that beatingathe market with active stock picking is extremely difficult.

Fama shared the Nobel with Robert Shiller and Lars Peter Hansen “for theiraempirical analysis of asset prices." Notably, Shiller has publishedaresearch on the growing field of behavioral finance that challenges some of theakey tenets of the efficient market hypothesis.

Aside from his work on efficient markets, Fama along with Kenneth French designed the three-factor model, a popular method for measuring the risk and performance ofaequity portfolios. They added size and value factors to the existing capitalaasset pricing model (CAPM).

The pair's research found that small-cap and value stocks with lower price-to-book ratios have outperformed the broader market over longer time periods. This has come to be known as the small-cap value premium. In other words, value tends to outperform growth over the long haul, while small beats large.

In an interesting coincidence, U.S. small-cap value stocks rose to new all-time highsaon the same day Fama was awarded the Nobel. The iShares Russell 2000 Value ETFa(IWN) climbed to a fresh record on Monday.

The small-cap value ETF has posted a total return of 24.3% this year as of Oct. 15, compared witha21.1% for the large-cap S&P 500, according to Morningstar. IWN has a 10-year annualized return of 8.5%,aversus 7.1% for the S&P 500 index.

Looking back even further,adata from Morningstar shows that from 1926 to 2011, small-capavalue stocks have returned 13.9% while large-cap growth stocks returned have 8.7%.

Note that Covestor offers a small cap value portfolio from Twinleaf Management.

Chart: The Dividend Guy

Photo credit: University of Chicago Booth School of Business

DISCLAIMER: aThe information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance does not guarantee future results.
Twinleaf Management

Twinleaf Management

Twinleaf Management LLC is a Connecticut-based registered investment adviser founded in early 2012. It is dedicated exclusively to investing in

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