Study on whether the Performance of Small Cap Index Outperforms the Performance of Large Cap Index

Study on whether the Performance of Small Cap

 Index Outperforms the Performance of Large Cap

 Index

 SURESH KUMAR.G¹, RENUKA.M. G², KISHORE KUMAR.V³ & DHINESH RAJ.R⁴.

 19MBA0010¹, 19MBA0060², 19MBA0072³,  19MBA0098⁴

VIT BUSINESS SCHOOL, VIT UNIVERSITY, VELLORE, TN

ABSTRACT

This paper focuses on the performance of Nifty Small cap 50 indexes, NIFTY Midcap 50 Index over Nifty50 large-cap index performance. The objective of the paper is to test the size impact in the Indian market and as stated in the Fama French four Factor Model to describe stock returns in asset pricing and portfolio management. We have tested here two hypotheses, the longer the holding period, the higher the average return. The second hypothesis, is the size impact, whether Small-Cap and Midcap Index outperforms the NIFTY 50 large-cap index.

Our hypothesis 1, was proven correct, higher the holding period, the higher the return irrespective of the type of the index. However, we couldn’t prove hypothesis 2, which proves that small-cap doesn’t outperform large-cap, even for a holding period of 10 years. Our analysis was further supported by the IIMA factor study, for the Indian market, where the small-cap sector underperforms the large-cap sector. 

INTRODUCTION

Market capitalization is the aggregate value of the company and it denotes the size of the company. If the share price of a particular company is high it doesn’t mean that that company will be the bigger. It all depends on how many numbers of outstanding shares the company holds. Therefore, the market capitalization of a company is the overall value of the share outstanding in other words, it is the multiple of the total number of shares outstanding and current price per share.

The stocks are classified based on the market capitalization as small-cap, mid-cap and large-cap. In India as per the NSE (National Stock Exchange) the stock’s value ranging below 8,500 crores will be small-cap companies, between 8,500 – 28000 crores will be called the mid-cap companies and the values above 28,0000 crores will be the large-cap companies. Whereas as per BSE(Bombay Stock Exchange) it follows 80-15-5 rule i.e. it calculates via the percentage of shares; companies covering 80% shares of the total market cap MOF, BSE will be the large-cap companies, the nest 80 – 95% will fall under the mid-cap and the rest last 5% will be the small-cap companies.

FAMA FRENCH FOUR FACTOR MODEL

This is one of the models proposed by Eugene Fama and Kenneth French to describe stock returns in asset pricing and portfolio management. The factors which contribute the performance of the portfolio is:

(1) the outperformance of small versus big companies,

(2) the outperformance of high book/market versus low book/market companies

 (3) momentum, winners minus losers.

(4) Market Risk premium

So, the four-factor returns will be,

·         Risk premium

·         SMB: "Small [market capitalization] Minus Big"

·         HML: "High [book-to-market ratio] Minus Low"

·         WML: winners Minus Losers

Factors	Last month	Last 3 months	Year to date	Since 01-Jan-1994
Market premium %	-0.2	3.9	0.1	3.7
SMB %	-1.0	-7.6	-19.5	-1.0
HML %	-4.2	-7.9	-29.1	5.5
WML %	5.1	-8.3	51.0	19.3

Note: Return since 01-Jan-1994 is an annualized geometric mean.

(Source: http://faculty.iima.ac.in/~iffm/Indian-Fama-French-Momentum/ )

HYPOTHESIS

Hypothesis: 1

     Longer the holding period, higher the returns and so the probability of loss will be less. The holding period is directly proportional to the portfolio returns.

Hypothesis: 2

       The longer period of holding small-cap can bring higher returns than the large-cap. The small-cap outperforms the large-cap.

PROCEDURE

We have taken the nifty large-cap TRI (Total Return Index) and calculated the returns at the different holding period such three years, five years and ten years. The results in the below table show that longer the period of holding, higher the returns.

	NIFTY 50 LARGE CAP RETURN
	Average	Minimum	Maximum	standard Deviation
3Year Holding period	60.15%	-38.98%	315.45%	61.89%
5Year Holding period	125.14%	-7.18%	580.60%	112.30%
10Year Holding period	316.94%	77.43%	656.24%	140.74%

The time period of analysis: 01 April’05 - 30 March’20

Source: https://www1.nseindia.com/products/content/equities/indices/indices.htm

	NIFTY 50 MID CAP RETURN
	Average	Minimum	Maximum	standard Deviation
3Year Holding period	34.95%	-49.24%	144.55%	39.51%
5Year Holding period	50.20%	-50.60%	190.68%	47.85%
10Year Holding period	126.34%	9.31%	462.25%	90.34%

   Similarly, the same calculation is followed for the mid and the small-cap. The mid-cap shows less variation for three-year period than the small and the large as shown below.

The small-cap shows the least returns than the large and the midcap even though the holding period is increased as shown below.

	NIFTY 50 SMALL CAP RETURN
	Average	Minimum	Maximum	Standard Deviation
3Year Holding period	29.84%	-57.13%	199.14%	49.10%
5Year Holding period	54.33%	-46.62%	209.57%	60.13%
10Year Holding period	112.25%	-24.36%	319.79%	67.12%

 

FINDINGS

So, it is proven that the higher the holding period, the rate of return is more irrespective of the type of the index and the size. Whereas the hypothesis 2 fails i.e. small cap doesn’t outperform the large-cap.

CONCLUSION

Our study has proven that small-cap, midcap indices have underperformed the large-cap index. Our study corroborates with the findings of IIMA on the performance of the factors in the Indian market as a whole. The reasoning which can be attributed is that Indian market investments are largely dominated by foreign institutional investors, where the preference is for investments of large-cap stock, as compared to mid-cap or small-cap stock.