When it comes to holding equity in client portfolios, I have almost always favored small cap (& micro cap) versus mid cap or large cap. Despite the global economic recession, this remains true. Here’s why:

  • Small cap companies are some of the best innovators and developers of technology.
  • They are frequently more efficient and flexible. Few layers of management etc.
  • They do not cut costs as deeply as larger companies do, so they come out of recessions faster.
  • They almost always have closer relationships between owners, managers, and staff.
  • They almost always have closer relationships with their clients, so they understand their client needs better.

Because they have smaller balance sheets, smaller reserve cushions, and lack abilities to diversify across product lines and geographies, they are higher risk enterprises (more likely to fail). As such they pay higher interest rates on bank loans. In order to exist, other things being equal, they must deliver higher returns on investment otherwise investors would never invest in small cap companies. Hence, small cap companies tend to have high risk-adjusted returns. This is true not only of US companies, but of international companies as well.