BNY Mellon: Large Cap Stocks Poised to Outperform Small Caps

Valuations metrics haven’t sent such a strong signal since 1983, BNY Mellon Beta Management study shows

Large capitalization stocks are poised to outperform small capitalization stocks over the medium to long term, according to an analysis by BNY Mellon Beta Management that uses the Standard & Poor’s 500 Index and the Russell 2000 Index for its models.

“Looking at the differential between the expected returns of large cap and small cap stocks, it appears that large caps have a good chance of outperforming small stocks over the next decade,” said Mark Keleher, CEO of BNY Mellon Beta Management, in a statement.  “Once you figure in the higher transaction costs for small caps, large caps appear even more attractive.”

In the study, the Standard & Poor’s 500 Index served as a proxy for large caps and the Russell 2000 Index served as a proxy for small caps.

BNY Mellon Beta Management, a San Francisco-based division of The Bank of New York Mellon, studied the expected returns of small caps versus large cap in June 2010 and updated its calculations in January 2011.

The division is a BNY Mellon Asset Management business that facilitates rebalancing programs and synthetic asset class exposure through the use of futures, swaps, index funds and exchange-traded funds (ETFs). BNY Mellon has $25.0 trillion in assets under custody and administration and $1.17 trillion in assets under management, services $12.0 trillion in outstanding debt and processes global payments averaging $1.6 trillion per day.

The June 2010 study concluded that large caps are undervalued compared with small caps, according to a Tuesday news release.

“When we updated our calculations in January, once again large caps appear to be significantly undervalued compared with small caps,” Keleher said.  “The last time the valuations metrics sent such a strong signal was in June 1983, and over the following decade the Standard & Poor’s 500 on average returned 10.4% annually, easily outperforming the Russell 2000, which returned an average of 6.5% annually over the same period.”

The study in June 2010 and the updated review in January 2011 calculated expected returns for small cap and large cap stocks in the United States and other developed global markets by examining the current price of individual securities, consensus earnings expectations over the next few years, and the long-term growth rate for the gross domestic product for the countries in which each company is based.

Transaction costs are estimated to be approximately 14 basis points higher for U.S. small caps compared with U.S. large caps and even higher in other global developed markets.   Turnover also tends to be higher in small cap indexes and small cap active portfolios than their counterparts at large cap indexes and large cap active portfolios, which will increase the odds of large cap outperformance, according to BNY Mellon Beta Management.  

“The relative attractiveness between large cap and small cap stocks varies over time, and small caps had a great run for the last few years,” Keleher said.  “However, the tide appears to have turned in favor of large caps.”

Read about BNY Mellon and subsidiary Pershing’s fourth-quarter 2010 earnings at AdvisorOne.com.

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