Tilting to U.S. Small Caps

May 14, 2015

U.S. cap-weighted, small-cap indexes have produced superior returns historically than their parent indexes. Barra equity factor models demonstrate that passive, small-cap portfolios also have style tilts when compared to the broader U.S. equity market. Some of these tilts can be favorable, such as cheaper valuations. Others can be unfavorable, such as lower earnings quality and weaker profitability. In this Research Insight, we show that by using equity risk models tailored to the investment universe, active managers can hedge out or avoid these unwanted exposures. Alternatively, they can employ a passive approach that aims to tilt toward higher quality and more profitable small-cap companies.