Small Cap Value: Why “Buying the Runts” Beats the S&P 500
Small Cap Value: Why “Buying the Runts” Beats the S&P 500
EXECUTIVE SUMMARY
- The Anomaly: Standard theory says risk equals return. However, historical data (1928-Present) proves that Small Cap Value (SCV) stocks have consistently outperformed Large Cap Growth stocks by ~3-4% annually over long periods.
- Authority Baseline: This analysis follows the Fama-French Factor Model, which identifies “Size” (SMB) and “Value” (HML) as independent drivers of excess returns.
- Scope Limitation: This strategy requires a minimum 15-20 year time horizon; SCV can underperform significantly for periods of 5-10 years (e.g., the 2010s).
- Anti-Exaggeration: This is not a “get rich quick” scheme. It is a “get rich slowly but painfully” strategy due to extreme volatility.
Everyone wants to own the next Apple (Growth). No one wants to own a boring regional bank or a metal stamping plant (Value). That is exactly why Small Cap Value works. It is the “Risk Premium” you get paid for holding the assets that are uncomfortable to hold. According to Team BMT Analysis, if you can stomach the tracking error, tilting your portfolio toward SCV is the most scientifically proven way to boost expected returns. Source: Dimensional Fund Advisors (DFA) Matrix Book
Scenario: You invest $10,000 in 1972.
- S&P 500 (Large Blend):
Grew to ~$1.5 Million. (Respectable). - Small Cap Value (Asset Class):
Grew to ~$4.5 Million.
The Difference: The “Size Premium” + “Value Premium” compounded over 50 years created 3x more wealth. - The Price: You had to endure drawdowns that were 10-15% deeper than the market (e.g., 2008).
Annualized Return Comparison (1928-2023)
| Asset Class | Annual Return |
|---|---|
| Large Cap Growth (S&P 500) | 10 |
| Small Cap Value | 14 |
*Chart Note: A 4% difference sounds small, but due to compounding, it results in massive divergence in terminal wealth over a lifetime.
CRITICAL SCENARIO: The “Value Trap” Filter
Why “Cheap” isn’t enough.
| Strategy | Methodology | Risk |
|---|---|---|
| Generic Value (Russell 2000 Value) | Buys stocks with low P/B. | High. Includes junk companies going bankrupt. |
| Profitability Screened (Avantis/DFA) | Buys low P/B + High Profits. | Lower. Filters out the “garbage.” |
Execution Protocol
Do not use the Russell 2000 Value index (bad methodology). Use targeted ETFs like AVUV (Avantis US Small Cap Value) or VIOV (S&P 600 Value). These funds filter for profitability.
Decision Order: Confirm Time Horizon (>15 yrs) โ Select Profitability-Screened ETF โ Allocate 10-20%.
Don’t go 100% SCV. It’s too volatile. A “Tilt” of 10% to 20% is optimal. This gives you the return boost without making your portfolio unrecognizable from the market.
SCV often crashes when Growth flies (e.g., 2020). You must have the discipline to sell your winners (Tech) to buy more SCV when it looks dead. This is where the Rebalancing Bonus (#429) is harvested.
Fail Condition: Selling SCV after 5 years of underperformance (e.g., 2015-2020) right before it explodes upward (2021-2022).
WEALTH STRATEGY DIRECTIVE
- Do This: Allocate a portion of your Roth IRA to Small Cap Value. Since it has the highest expected return, you want that growth to be tax-free.
- Avoid This: Market timing SCV. Factor premiums are “lumpy.” They can deliver 10 years of returns in 2 months. You must be in the seat when the bus leaves.
Frequently Asked Questions
Why Avantis (AVUV) over Vanguard (VBR)?
Vanguard’s VBR is “Mid-Cap” disguised as Small-Cap. AVUV targets smaller, deeper value stocks with a profitability screen, offering purer factor exposure.
Is this better than the Nasdaq?
Historically, yes. But recently (last 10 years), Nasdaq won. SCV is a bet on “Mean Reversion.” If you believe Tech valuations are too high, SCV is the antidote.
Does this work internationally?
Yes. The premium is robust globally. Funds like AVDV (International Small Cap Value) allow you to capture this factor outside the US.