In my 401k I have always allocated a greater percentage of my portfolio into mid cap funds because they seem to be riskier and have a higher upside. Yet, as of the past year or so, the large cap funds are beating them.

Is there any research or trains of thought that says what is more likely to do what over 30 years between a mid-cap fund based on, say, the Russell 2000 vs. a large-cap fund based on, say, the S&P 500?

I was looking at this Morningstar brochure "The Perfect Mix of Large-, Mid-, and Small-Cap Stocks" (PDF), but is that always the case? Like over 30 years, should mid cap and small caps constantly beat the S&P 500?

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    Doesn't "past performances are no indication of future performances" invalidate most all 'research' when it comes to stock purchasing? – DA. Apr 28 '15 at 22:36
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    True but there's certain historical lessons that can be helpful. Like holding index funds and not getting bombarded with trading fees can often beat most actively managed mutual funds – Frank Visaggio Apr 28 '15 at 22:43
  • True, that's a good point about the ancillary costs. – DA. Apr 28 '15 at 22:50

I think it's safe to say that Apple cannot grow in value in the next 20 years as fast as it did in the prior 20. It rose 100 fold to a current 730B valuation. 73 trillion dollars is nearly half the value of all wealth in the world.

Unfortunately, for every Apple, there are dozens of small companies that don't survive. Long term it appears the smaller cap stocks should beat large ones over the very long term if only for the fact that large companies can't maintain that level of growth indefinitely.

A non-tech example - Coke has a 174B market cap with 46B in annual sales. A small beverage company can have $10M in sales, and grow those sales 20-25%/year for 2 decades before hitting even $1B in sales. When you have zero percent of the pie, it's possible to grow your business at a fast pace those first years.

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    It is also worth noting that strong growth companies are going public at a much later time. For instance, for Facebook to exhibit the same growth as an investment in Microsoft did, Facebook would have to become worth 45 trillion. Where I am implying that the remaining "small cap" companies which did go public are not great growth stories. A portfolio WOULD have performed great when a Facebook was a small cap company, but it was prohibited from having any exposure to it, compared to past times when older studies were written about small caps providing great returns. – CQM Jun 28 '15 at 2:00
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    Good point. After IPO, Facebook was never a small or even mid-cap. If you are saying that late IPOs reduce the small/mid effect, I agree. – JTP - Apologise to Monica Jun 29 '15 at 15:47
  • @CQM I think that lesson is in the data somewhere, but is likely quite industry specific. Facebook is different because as a tech company, it needed very little capital at the outside, meaning it could have high levels of growth prior to getting the cash from an IPO. Where a capital-intensive industry (say, mining) would need cash at the outset, and therefore could easily be mid-cap after an IPO, and if that IPO was set because of a specific need for cash for a specific project, that IPO could be the turning point in growth. I have no idea how common the two scenarios are, however. – Grade 'Eh' Bacon Jul 18 '16 at 21:33

From Dimson, Elroy, Paul Marsh, and Mike Staunton. Triumph of the Optimists: 101 Years of Global Investment Returns. Princeton, N.J: Princeton University Press, 2002:

Disappointingly, the small firm effect has not proved the road to great riches since soon after its discovery, the US size premium went into reverse. This was repeated in the United Kingdom and virtually all other markets around the world.

Despite their disappointing performance in recent years, the very long-run record of small-caps remains one of outperformance in both the United States and the United Kingdom. Furthermore, mid- and small-size companies are still an important asset class. Their differential performance over long periods of history shows that there is useful scope for investors to reduce risk by diversifying across the “large” and the “small” capitalization sectors of the market. Furthermore, given the pervasiveness of the size effect across the entire size spectrum, it is important to all investors since the size tilt of any portfolio will strongly influence its short- and long-run performance. This holds true whether there is a size premium or a size discount. The size effect has certainly proved persistent and robust. What is at issue is whether we should continue to expect a size premium over the longer haul.

And accompanying charts:

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And one chart from BlackRock:

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Efficient Frontier has an article from years ago about the small-cap and value premiums out there that would be worth noting here using the Fama and French data.

Eugene Fama and Kenneth French (F/F) have shown that one can explain almost all of the returns of equity portfolios based on only three factors: market exposure, market capitalization (size), and price-to-book (value).

Wikipedia link to the factor model which was the result of the F/F research.

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    Quote a small, relevant portion, perhaps? – Chris W. Rea Apr 28 '15 at 21:27

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