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Roman Kouzmenko

Roman Kouzmenko

Executive Director, MSCI Core Equity Research

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Did Size Matter for Small-Cap Outperformance?


  • Nov. 9 saw unusual market movements fueled by news of a COVID-19 vaccine. U.S. small-cap indexes outperformed large caps, and many have called this the start of a size reversal.
  • Small-cap-index outperformance was driven by mostly riskier assets, with higher beta and lower profitability compared to large caps, and by a rotation out of momentum. Size-factor returns did not matter.
  • Systematically analyzing performance using risk-analytics tools such as equity risk models helps uncover drivers of risk and return and may help investors avoid jumping to intuitive but wrong conclusions.

With the announcement of a COVID-19 vaccine, Nov. 9 saw unusual returns in equity indexes and risk-model factors. As a consequence, the financial press began to focus a great deal on the possibility of a reversal in the performance of small- and large-cap stocks, with headlines such as “Why the Small-Cap Rally Is Just Getting Started.”1 Indeed, the MSCI USA Small Cap Index had a daily return of 3.03% on Nov. 9, compared to 0.82% for the MSCI USA Index.


These Numbers Would Seem to Confirm the Headlines, but …

What really drove this performance differential? Was it the size factor, as it seems on the surface, or was there more than meets the eye? Let’s analyze that day’s active return using a U.S. equity risk model to understand this better.

Sticking with the MSCI USA Small Cap Index as a proxy for small-cap stocks, we note that while the index is constructed by selecting smaller companies from the U.S. equity universe by market capitalization through a rules-based methodology, it does not target pure exposure to the size factor, net of all other factors. This construction results in high exposure to the size factor as expected (-2.17 as of Nov. 9),2 but also leads to non-negligible active exposures to several other risk style factors, as shown in the exhibit below.


MSCI USA Small Cap Index Had Non-Negligible Active Exposures to Factors Other than Size

Active style-factor exposures (excluding size) of the MSCI USA Small Cap Index relative to the MSCI USA Index as of Nov. 9, 2020. Based on the MSCI Barra US Total Market Model for Long-Term Investors (USSLOW).


Size-Factor Returns Were Barely Noticeable

Given these exposures, how did these factors perform on Nov. 9? The exhibit below shows that factors such as beta and momentum had the largest absolute returns, whereas the size factor’s return was very close to 0, the smallest absolute return among all style factors that day.


Size Was Not a Big Factor in Nov. 9 Performance

Style-factor returns of the MSCI Barra Total Market Model for Long-Term Investors (USSLOW) on Nov, 9, 2020.


What Did Drive Small-Cap Outperformance?

Multiplying active factor exposures by factor returns gives us the factor-return contributions to the MSCI USA Small Cap Index’s active return. The 10 largest contributors by absolute value among all model factors are shown below. We observe that:

  • Nine out of 10 contributions were positive.
  • Most of the outperformance of the MSCI USA Small Cap Index relative to the MSCI USA Index was driven by riskier and lower-quality assets with higher exposures to beta and lower exposures to profitability. The rotation out of momentum also contributed significantly.
  • The mid-capitalization factor (also part of the size factor group) had a modest contribution of approximately 20 basis points, only around a tenth of the total active return.


Largest Contributors to MSCI USA Small Cap Index Outperformance Did Not Include Size

Top 10 absolute active-return contributions to the MSCI USA Small Cap Index relative to the MSCI USA Index from risk-model factors of the MSCI Barra Total Market Model for Long-Term Investors (USSLOW) on Nov. 9, 2020.


The Simplest Explanation Isn’t Always the Right One

Don’t get us wrong. The largest active factor exposure of the MSCI USA Small Cap Index comes, unsurprisingly, from the size factor — which, as a result, usually matters a lot, driving most of the index’s relative performance. That said, size did not matter at all in terms of explaining active index performance on Nov. 9. Instead, other style factors (beta, momentum and profitability) to which the index had weaker but non-negligible exposures explained the performance differential that day.

Analyzing the performance through a factor lens helped uncover the true drivers of index return and could have helped investors avoid jumping to intuitive but wrong conclusions.


The author thanks George Bonne for his contribution to this blog post.


1Sonenshine, J. “Why the Small-Cap Rally Is Just Getting Started.” Barron’s, Nov. 10, 2020.

2Note that a negative (positive) exposure to the model size factor indicates a greater allocation towards small (large) caps.



Further Reading

Are Momentum’s Wings Finally Starting to Melt?

Using Factors as a Magnifying Glass for Equities

Factor Investing