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Key takeaways

  • With mega-cap technology stocks dominating markets, some investors have questioned the role of smaller companies inside portfolios
  • History suggests that small-cap companies could be well positioned to benefit from a COVID-19 economic recovery
  • Index-tracking exchange traded funds (ETFs) offer numerous ways to efficiently access the “size” factor in anticipation of a rebound in U.S. economic growth

The biggest U.S. tech stocks are leading the way in terms of performance in 2020 and as a result are taking up more real estate in broad U.S. stock indexes.1

Six companies—Facebook, Apple,, Netflix, Google-parent Alphabet and Microsoft—represent 25% of the S&P 500 Index’s market value, from 17% to start 2020.2 For perspective, the weight of the same stocks (collectively dubbed FAANGM) in the S&P 500 has more than doubled, from 9%, since the start of 2015. Milestones are piling up: In August, Apple became the first U.S. company to achieve a $2 trillion market capitalization.3

Figure 1: ‘FAANGM’ weight changes in the S&P 500

Chart: ‘FAANGM’ weight changes in the S&P 500

Source: Morningstar (as of August 31, 2020). Subject to change.

Given the headlines, I’ve heard from investors asking whether smaller stocks deserve a place in their portfolios. Conversely, others have asked questions about the potential concentration risks that owning so much tech might pose. No matter the view, it is a great time to brush up on the “size” factor , which exhibits an academically rigorous justification for why it still makes sense to consider smaller companies for the long term.4

A step-back view on the “size” factor

During downturns, small stocks have tended to underperform, in part because small stocks often have fewer buffers to survive economic shocks.5 But smaller companies have historically rewarded investors for their higher risk over full market cycles. In addition, the size factor may be a particularly useful investment in the current economic climate given that it has typically outperformed during the recovery period of an economic cycle relative to other factors.

Figure 2: Factors in the economic cycle

Chart: Factors in the economic cycle

For illustrative purposes only.

An opportunity in times of economic recovery

Smaller companies may have more to gain from the U.S. economy reopening, just as they had more to lose when the economy closed. They also tend to be less globally oriented, and more sensitive to domestic economic conditions. Undoubtedly, the U.S economy has taken positive steps forward. Even so, most states are still enforcing social distancing, unemployment remains over 10%, and in some states COVID-19 cases have risen over recent months rather than fallen. Given the state of the U.S. economy, smaller companies have yet to have their opportunity to shine, despite their impressive ability to keep pace with the S&P 500 since the March lows even without the support of FAANGM.6

Capturing the size factor among large-cap companies

The size factor focuses on smaller companies outperforming larger ones, and there are many ways to gain this exposure. One way would be to directly invest in small cap companies, for instance in funds that seek to track popular benchmarks such as the S&P SmallCap 600.

It’s also possible to be a smaller company in a large-cap world. Take for example the MSCI USA Low Size Index, which allocates more weight to smaller companies within a large and mid-cap universe. This index provides exposure to the size factor while maintaining some exposure to FAANGM, and provides investors with a way to access the larger-cap portion of the U.S. market while dissipating some of the concentration risk associated with big tech. Research suggests that accessing the U.S. market through this size factor lens could lead to outperformance over time.4

Figure 3: Breaking down index market capitalizations

Chart: Breaking down index market capitalizations

Source: BlackRock (as of August 31, 2020). Market Capitalization buckets as follows: Large > $64.8B, Medium/Large > $14B, Medium > $4.5B, Small/Medium > $1.6B, Small <$1.6B Weightings subject to change.

Sizing up your ‘size’ position

Allocating to smaller companies provides a unique set of risks that have historically been rewarded over time, but that may cause the companies to struggle in challenging economic environments. Yet, with the S&P 500 now having one-quarter of its exposure in six securities, and an economic recovery potentially acting as a catalyst for smaller firms, the size factor may be of interest to many investors.

For some investors allocating directly to small caps, the iShares Core S&P Small-Cap ETF (IJR), which seeks to track the S&P SmallCap 600, may provide the strong size exposure they are looking for as the economy postures to reopen. For others who may be looking for a less concentrated approach to the large-cap universe, funds such as the iShares MSCI USA Size Factor ETF (SIZE), which seeks to track the MSCI USA Low Size Index, provides investors with size exposure by creating a more balanced approach to larger-cap investing.

Robert Hum, CAIA
U.S. Head of Factor ETFs
Contributing authors: Christopher Carrano, Elizabeth Turner
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