Fewer Stocks Doesn’t Mean a Smaller Size Premium
The number of stocks in the US market has declined from a high of more than 6,600 in 1997 to about 4,000 at the end of 2022. Several reasons have been proposed. For example, some investors suggest private equity activity has reduced the number of small cap stocks. However, “Why?” is probably less pertinent to investors than the question: “Does it matter?”
One way to think about concerns with a shrinking opportunity set is to look at the relation between number of securities and size premium across different markets. While the historical magnitude of the size premium has varied across countries, there’s no evidence this variation is tied to number of stocks. The largest size premium observed within developed markets, 5.76%, came from Ireland with a stock market population of just 41 on average. On the other hand, the similarly sized market of Portugal (45 stocks on average) produced a negative size premium. Larger markets are found on both sides of the size premium spectrum as well. Japan (2,416 stocks) has been in the top quartile; Canada (715 stocks) in the bottom quartile.
While the average premium has been insensitive to stock count, holding more stocks provides greater diversification. The size premium in individual markets can be volatile, so global diversification may give investors a more reliable avenue to outperform the market.
Source: Dimensional using data from Bloomberg. Start date determined by availability of all cap coverage across countries. Size premium is defined as the return difference between small cap and large cap securities in each country. Within each country, small stocks and large stocks are defined as the bottom 12.5% and top 87.5%, respectively, of cumulative market cap ranked on firm size. The smallest 0.1% of market capitalization in each market is excluded, and the sample is restricted to exchange-traded stocks that meet minimum liquidity and listing requirements. Assumes annual rebalancing.
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