Small Cap ETFs: The Size Premium Explained by Fama-French
Investors seeking diversification and superior performance are increasingly interested in small caps, notably through passive vehicles like Small Cap ETFs. One of the most popular in Europe is the Lyxor MSCI World Small Cap (ISIN LU1275219762), which offers global exposure to small caps with a competitive TER of 0.35%. This article analyzes the size premium, a key concept in factor investing popularized by Fama and French, and its impact on the performance of Small Cap ETFs, particularly since 2000. We will also put into perspective the specific risks related to this asset class (volatility, liquidity) to formulate allocation recommendations suitable for intermediate French investors.
The Size Premium According to the Fama-French Model
The three-factor model by Fama-French, published in the 1990s, revolutionized the understanding of stock returns by identifying three sources of systematic return: market risk (beta), the value premium, and the size premium. The size premium corresponds to the historical outperformance of small caps relative to large caps, generally attributed to higher risk or lower analyst coverage of small caps.
Historically, the size premium represented an excess return of about +3% per year over several decades, notably in the United States. This outperformance was confirmed by empirical studies covering the period 1927-1999, where small caps delivered an annualized return approximately 3 percentage points higher than large caps, adjusted for market risk.