Among the various investment factors, size is arguably the easiest to comprehend. Put simply, the size factor is rooted in the notion that smaller stocks can outperform large-caps, though small-caps are, broadly speaking, more volatile.The Fama-French Three-Factor Model designed by Nobel Laureate Eugene Fama and famed researcher Kenneth French states “small company stocks (small cap) tend to act very differently than large company stocks (large cap). In the long run, small-cap stocks have generated higher returns than large-cap stocks; however, the extra return is not free since they have higher risk.” 1 Through the first half of 2018, small-caps are receiving renewed attention due in large part to their out-performance over large-cap equivalents. Year-to-date, as of July 13, 2018, the Russell 2000 Index and the S&P SmallCap 600 Index are up an average of 11.45% compared to 4.77% for the S&P 500 Index. 2 [1] The healthcare sector is one of the primary drivers of this year's small-cap resurgence. Importantly, there are multiple reasons why smaller healthcare companies are impressing this year.
Examining Small-Cap Healthcare Catalysts
“Small health care companies are outperforming large caps in health care from increased expectations for acquisition of smaller companies, stronger innovation from smaller companies and that smaller companies may be more immune to concerns about regulatory pressures in healthcare,” said S&P Dow Jones Indices.3Another factor in favor of the broader small-cap complex, including the healthcare sector, is that smaller stocks are often more dependent on the U.S. for large portions of their revenue than are large companies. By generating more revenue on a domestic basis, smaller companies are less vulnerable to a stronger dollar than large, multi-nationals the do businesses in scores of ex-US markets. As the chart below indicates, small-cap healthcare companies generate a significant portion of sales in the U.S.
On a note related to the strong dollar, the Federal Reserve has boosted interest rates twice this year and two more rate hikes could be delivered before the end of 2018. Higher financing costs can be burdensome to some smaller companies that are reliant on capital markets, underscoring the point that investors should evaluate smaller healthcare companies with enough cash to survive at current burn rates.Related:
Where Two Technologies of Tomorrow Meet Today An Important Trait
In the world of healthcare index and exchange traded funds (ETFs), there are important industry-level differences between large- and small-cap products. Over the past several years, the large-cap S&P 500 Health Care sector has seen its weights to biotechnology, life sciences and pharmaceuticals decline while its exposure to healthcare equipment and services firms has increased.Conversely, the S&P SmallCap 600 health care sector has witnessed rising exposure to biotechnology, life sciences and pharmaceuticals companies.4This is an important sector attribution at a time when smaller biotechnology and pharmaceuticals companies are playing significant roles in small-cap healthcare's leadership.
Small Cap Health Care Names Have Seen Outperformance Over Their Large Cap Counterparts
A Basket Approach To Smaller Healthcare Names
For more information on how to invest on mid- and small-cap healthcare equities,
please click here.
1Source: Portfolio Solutions
https://portfoliosolutions.com/latest-learnings/fama-french-three-factor-model2 Source: Bloomberg, L.P., as of July 13, 2018
3 Source: S&P Dow Jones Indices July 2, 2018 http://www.indexologyblog.com/2018/07/02/small-cap-premium-is-5th-biggest-in-history/4 Source S&P Dow Jones Indices March 28, 2018 http://www.indexologyblog.com/2018/03/28/whats-in-a-sector/
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