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Can small cap indices score a hat-trick?

by Robert St George on Jan 29, 2014 at 08:51

Can small cap indices score a hat-trick?

‘Can we dare to wish for a third good year for smaller companies?’ asked Paul Marsh, emeritus professor of finance at the London Business School.

Marsh and fellow emeritus professor Elroy Dimson (pictured) produce the Numis Smaller Companies index (NSCI), which captures the smallest 10% of the UK equity market.

The index enjoyed a strong 2012, when it returned 25.7% compared with 12.3% from the FTSE All Share index. But last year was even better.

In 2013, the NSCI offered a total return of 31.7% versus the FTSE All Share’s 20.8%. It was also on top in each quarter of the year, with no negative quarters.

The question is whether that run can continue, or whether 2014 will look more like 2011 when the NSCI lost 8.8% while the FTSE All Share slipped by only 3.5%.

Historically the odds are good. ‘This is a consistent story,’ said Dimson of small caps’ outperformance.

The NSCI has now beaten the FTSE All Share by an annualised 3.5% since the professors’ database began in 1955.

The margin of superiority is similar over the past decade, at 3.7% per year. Moreover, Dimson noted of the recent record, ‘this is a period that has not been special for Britain’ when small caps could have been flattered by favourable domestic economics.

Yet, as Dimson is aware, ‘There are no guarantees over a 12-month period.’ So what are the more forward-looking omens?

The preferred tool for Marsh and Dimson is dividend yield. They eschew the more conventional cyclically adjusted price-to-earnings ratio due to the lack of reliable earnings figures before the 1980s.

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