Recent Large-Cap Stock Outperformance and Its Impact on US Equities

Abstract

Although a significant amount of literature has been written on the small-size effect, the recent outperformance of large, mega-cap stocks in the United States has been noticeable by most investors. The impact of this outperformance on passive, smart beta, and active investing is likely underestimated, however. This relationship has made indexes less diversified by impacting the effective number of stocks measure within these indexes. The portfolio construction of factor (smart beta) portfolios has become more significant, as large-cap stocks within factors have outperformed small-cap stocks within the same factor. The outperformance of large-cap stocks has also impacted active investing. Active investors typically have a small or equal-weight tilt relative to the benchmark, therefore the recent outperformance of large-cap stocks has provided a headwind to active investment. The dominance of large caps is unlikely to continue, but their performance and impact is crucial to acknowledge and understand.

TOPICS: Security analysis and valuation, analysis of individual factors/risk premia, performance measurement

Key Findings

• ▪ US large-cap stocks have outperformed since 1984.

• ▪ The impact of this outperformance is broader than many investors realize.

• ▪ This outperformance has impacted passive, smart beta, and active investing.