Has the Size Premium Disappeared?

Small-cap stocks have underperformed the broader markets since the “discovery” of the size premium in 1981. But research shows that a segment of those small-cap stocks have performed well and that now is a compelling time to invest in them.

The size effect was first documented by Rolf Banz in his 1981 paper, “The Relationship Between Return and Market Value of Common Stocks,” published in the Journal of Financial Economics. After the 1992 publication of Eugene Fama and Kenneth French’s paper, “The Cross-Section of Expected Stock Returns,” the size effect was incorporated into what became finance’s new workhorse asset-pricing model, the Fama-French three-factor model (adding value and size to the CAPM’s market beta). It has since been included in newer models, including the Fama-French five- and six-factor models and the four-factor q-theory model of Lu Zhang.

Unfortunately, the size premium basically disappeared in the United States after the publication of Banz’s work. From 1982 through August 2020, the stocks in the CRSP deciles 1-5 (large stocks) returned 11.8% per annum, outperforming the stocks in deciles 6-10 (small stocks), which returned 11.3% per annum.[1]

We now turn to reviewing the possible cause of the disappearance of the size premium – the performance of small-growth stocks.

The small-growth anomaly

A major anomaly for asset pricing models has been the performance of small--growth stocks. As you can see in the table below, using data from Ken French’s data library, small-growth stocks have had by far the worst performance among the four asset subclasses, despite experiencing far greater volatility than large-growth stocks. The rest of the data show returns positively correlated with risk (large value has provided higher returns than large growth, and small value has provided higher returns than small growth).

July 1926-August 2020


Annualized Return (%)

Annual Standard Deviation (%)

Fama-French U.S. Large Growth Research Index



Fama-French U.S. Large Value Research Index



Fama-French U.S. Small Growth Research Index



Fama-French U.S. Small Value Research Index



See Important Disclosures

The performance of small-growth stocks has been so poor that over the more than 40-year period from 1980 through August 2020, they underperformed long-term Treasury bonds (8.2% versus 9.4%) while experiencing more than twice their volatility (23% versus 11.0%). Over the same period, large-growth, large-value and small-value stocks returned 12.6%, 11.7% and 13.9%, respectively.

Such poor performance has also been found for penny stocks, stocks in bankruptcy and IPOs; all have experienced lower returns than we would expect (i.e., are anomalies for asset pricing models and market efficiency). Behavioralists explain these outcomes as the result of the “lottery effect,” or a preference for investments that exhibit positive skewness in returns. Positive skewness occurs when the values to the right of (greater than) the mean are fewer but farther from the mean than are values to the left. In other words, investors are willing to accept low average returns in exchange for the possibility of getting some extremely positive outcomes. One can think of it as investors searching for the next Google or Apple.