The valuation gap between large-cap stocks and small-cap stocks alongside growing small-cap tailwinds leave the asset class favorably positioned looking ahead. Investors seeking to reallocate to small-caps to capture potential outsized returns would do well to consider the Neuberger Berman Small-Mid Cap ETF (NBSM ).
Small-cap stocks, when compared to large-caps, traded at a trailing 12-month price-to-earnings ratio experienced in less than 10% of the time since 1998 as of the end of September. That’s according to Raheel Siddiqui, senior investment strategist, and Amr Hanafy, CFA, research analyst at Neuberger Berman in a recent paper. This in turn creates the potential for significant outperformance in the next decade by small-cap stocks.
The pair calculated the valuation differential between the Russell 1000 and Russell 2000 (minus unprofitable companies). They compared this to the relative 10-year annualized return since 1998. The result “implies that high-quality members of the Russell 2000 have the potential to outpace the Russell 1000 by as much as 5.6% a year over the next 10 years.”
Small-cap stocks also have a number of tailwinds working in their favor, according to the authors. These include a favorable risk/return cycle position, the inverse correlation of the U.S. dollar with small-cap valuations compared to large-cap peers, and rate cuts. Other potential tailwinds include global capex growth, likely to boost the bottom and top line of small companies, and relative size to relative returns favoring small-caps.
“We believe the relative size of the two categories implies that a mere 1% reallocation from large to small caps could boost small cap returns by 20%,” the authors wrote.
Capture Small-Cap Returns Potential With NBSM
NBSM is actively managed and invests in small- and midcap companies with elevated, sustainable growth potential. The fund managers use bottom-up analysis when evaluating companies. It focuses on quality companies that generate reliable free cash flow and elevated profitability. The companies also have conservative balance sheets and business models that set them apart from peers. The overall approach to SMIDcap investing results in a diversified portfolio compared to benchmarks.
The strategy also seeks to mitigate the elevated volatility inherent to small- and midcap investing while reducing downside risk. NBSM carries an expense ratio of 0.74%.
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