Small Is Beautiful
The Italian economy was once characterized by the surprising performance of its small and medium firms, often organized in networks and districts. But "Small is beautiful" seemed to have lost its appeal after globalization, offshoring, and more recently, the world financial and banking crisis, which have seriously undermined SMEs. But it hasn't gone out of fashion at Borsa Italiana. An empirical study of small caps listed in Milan highlights the vastly better performance of these stocks with respect to either large companies or the stock exchange index.
Small caps outperform the biggies both on the short-term and the the medium-long term. The study, published on the fall issue of Economia & Management, was conducted on ordinary stocks listed on the Italian stock exchange from December 21, 1988 to December 21, 2009 (560 companies considered over a time-span of 252 months). The comparative analysis of the small portfolio decile with respect to the big portfolio decile, sees the former outperforming the latter by 14%, if stock is held for one year, climbing to 66% for three years, rising to 183% over five years, and jumping to 581% for a 10-year horizon. In terms of frequency, small caps overtake big caps 70% of the time in the space of one year. Such percentage grows to 89% for five years and to 100% for ten years.
There are various reasons behind this higher performance. Looking at the US case, the motivations are not only linked to a "size-effect", but are to be ascribed to risk being higher than that usually captured by existing risk-return models, to higher transaction costs, limited information and lower liquidity of small cap stocks. Similar studies have not yet been conducted for the Italian equity market. Our analysis has however sought to position the investment in small caps made by an investor, by comparing his/her returns with those provided by private equity funds, which also invest in small and medium firms with medium-to-high risk profile. Returns net of taxes are substantially the same for Italian private equity funds and small portfolios over the 1999-2009 period (both yield around 18%).
Thus basically small caps are an investment class that can be assimilated to private equity funds. Over the last few years, specialized operators have emerged investing private capital in small and medium listed companies. This phenomenon is called PIPE (Private Investment in Public Equity). It has existed for a few years in the US stock market and it is now having its early development in Italy, too. It may well be that thanks to these new ways of investing financial capital, small will continue to be beautiful on the Italian stock market.