The Small-Cap Alpha Myth

Abstract

Investment lore has it that there is more opportunity to earn abnormal profits from small–capitalization stocks than large–capitalization stocks–that the small–cap market is less efficient. The authors find no evidence that active small–cap managers add value consistently. They demonstrate three common performance evaluation errors that contribute to what they call the small–cap myth. They also discuss securities analysts' neglect of small stocks as well as the higher cost of researching and trading them. Whatever the differential in market inefficiency between large and small might be, the authors conclude it is not sufficient to justify the average manager's higher cost of researching and trading smaller stocks.