Impact of Large- and Small-Cap Stocks on Fund Performance
Understanding the differences between large-cap stocks and small-cap stocks may help investors comprehend how certain unit trust funds behave in different market cycles.
Large-cap stocks vs. Small-cap stocks
Large-cap stocks are defined as stocks of companies with high market capitalisation. In this context, market capitalisation refers to the total market value of a company and is obtained by multiplying the company’s stock price by the total number of shares in issue. Large-cap stocks tend to be industry leaders, have established track records and generally enjoy stable earnings growth. Due to their size of operations, large-cap companies are better-equipped to ride out challenging economic conditions compared to smaller-cap companies. As a result of these features, the share prices of large-cap companies tend to be relatively more resilient than smaller-cap stocks.
In contrast, small-cap stocks tend to be stocks of newer players or companies that operate in new growth industries. Due to their smaller revenue base, small-cap companies can potentially generate higher growth rates compared to large-cap companies. However, their earnings tend to be less predictable and are more vulnerable to a slowdown in economic conditions. For this reason, the prices of small-cap stocks are more volatile and these stocks are considered to be riskier investments as compared to large-cap stocks.
Performance of FBM KLCI and FBM Small Cap Index
To illustrate the volatility of small-cap stocks relative to large-cap stocks, Figure 1 shows the performance of the FTSE Bursa Malaysia (FBM) KLCI and the FBM Small Cap Index from 3 January 2017 to 31 March 2022.
During the start of the Covid-19 pandemic in early 2020, the FBM KLCI registered a year-to-date decline of 23% as at 19 March 2020, only to subsequently rebound by 33% by the end of 2020. Over the same period, the FBM Small Cap Index recorded a steeper decline of 46%, before subsequently doubling by end-2020.
Thus, compared to funds which focus on large-cap stocks, funds which focus on small-cap stocks tend to experience sharper declines during market downturns along with stronger rebounds during market recoveries. As such, investors should note that unit trust funds which focus their investments on small-cap stocks are likely to experience a higher volatility of returns as compared to funds which invest in large-cap stocks.
Price Performance of Large-cap vs Small-cap Funds
In periods of market uncertainty, the price performance of small-cap stocks is inclined to be more volatile due to their lower level of stock trading liquidity and the smaller base of institutional fund holdings. In comparison, the price performance of large-cap stocks generally tends to be more stable during periods of market weakness as buying support from institutional investors will emerge when these stocks’ valuations fall to levels which are deemed to be attractive.
During market recoveries, the improved sentiment by market participants may lead to a sharper rebound for small-cap stocks as their lower stock trading liquidity makes their share prices more sensitive to buying interest by investors.
Depending on the unit trust funds’ portfolio mix of large-cap stocks versus small-cap stocks, the funds will tend to register a varying range of performances. For example, during periods when small-cap stocks outperform large-cap stocks, the performance of unit trust funds which are focused on small-cap stocks tend to outpace funds with a higher focus on large-cap stocks, and vice versa.
Public Mutual’s Investment Strategy
Public Mutual’s investment philosophy focuses on investing in stocks with good fundamentals and resilient earnings. With this fundamental approach to stock selection, our investment universe includes large-cap stocks with resilient earnings as well as selected small-cap companies which have the potential to grow into companies with larger market capitalisations over time. This investment approach enables our funds to ride through challenging periods of market volatility towards delivering consistent returns to our unitholders over the long term.
As small-cap stocks tend to have a lower level of stock trading liquidity and comprise of a smaller base of institutional fund holdings to provide buying support, their price performance is inclined to be more volatile during periods of elevated market uncertainty. In comparison, the price performance of large-cap stocks is generally more stable during periods of market weakness as buying support from institutional investors will emerge as the valuations of these stocks become more attractive.
Depending on their risk profiles, investors who prefer more-stable equity returns over the long term may invest in unit trust funds that focus a larger proportion of their portfolios on large-cap stocks with more-resilient earnings. Meanwhile, investors with higher risk tolerance in pursuit of potentially-higher returns over the long term may choose to invest a higher percentage of their portfolios in unit trust funds which are focused on small-cap stocks.
This article is prepared solely for educational and awareness purposes and should not be construed as an offer or a solicitation of an offer to purchase or subscribe to products offered by Public Mutual. No representation or warranty is made by Public Mutual, nor is there acceptance of any responsibility or liability as to the accuracy, completeness or correctness of the information contained herein.