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Capturing the American Dynamism in US Small Cap Equity ETFs

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Early Mover Advantage in Small Cap Equities

Fam­i­lies are always ris­ing and falling in Amer­i­ca.” - Nathaniel Hawthorne, The House of Sev­en Gables

What Hawthorne said about Amer­i­can fam­i­lies can just as eas­i­ly be applied to Amer­i­can com­pa­nies. The table below con­tains snap­shots of the top twelve hold­ings of the S&P 500 over the last sev­er­al decades (note — data from Van­guard S&P 500 Index Fund -VFINX, often used as a proxy for S&P 500).

Top S&P 500 holdings - decade comparison | Swan Blog

I’d like to inter­pret this table as evi­dence of the dynam­ic nature of the Amer­i­can econ­o­my. Joseph Schumpeter’s “cre­ative destruc­tion” is on dis­play, as the young and hun­gry sup­plant the old and staid. Not only are some of today’s largest com­pa­nies less than a decade or two old, they oper­ate in indus­tries that did not even exist 10–20 years ago. Con­trast our econ­o­my with that of, say, France, where the youngest com­pa­ny in the CAC 40 Index was found­ed in 1967 (exclud­ing merg­ers).

Of course, none of these com­pa­nies start­ed out on the top of the tables. Whether ten years old or a hun­dred years old, every large com­pa­ny start­ed off as a small com­pa­ny. Accord­ing to a recent piece in The Atlantic, Richard Fos­ter of the Yale School of Man­age­ment stat­ed that the aver­age lifes­pan of a com­pa­ny in the S&P 500 fell from 67 years in the 1920’s to just 15 years today. More­over, Fos­ter pre­dicts that by 2027 near­ly 75% of the com­pa­nies in the S&P 500 today will be replaced by new firms.

Those with a long-term time hori­zon will­ing to invest with the up-and-com­ing seg­ments of the econ­o­my have been reward­ed. Accord­ing to Morningstar/Ibbotson’s data, since 1925, small caps have aver­aged almost 2% more per year ver­sus large caps. Aca­d­e­mics have explored this “small cap pre­mi­um” in great detail.

Growth of Small Cap holdings over time | Swan Blog

The down­side, how­ev­er, is that high­er returns are cou­pled with high­er risk. Many small­er com­pa­nies will nev­er become large com­pa­nies, and many will die along the way. Dur­ing peri­ods of mar­ket tur­bu­lence, small caps tend to have high­er volatil­i­ties and draw­downs than their large cap cousins.

Large vs Small Cap - Risk Return comparison | Swan Blog

With both the upside poten­tial and down­side risks in mind, Swan Glob­al Invest­ments has recent­ly applied the Defined Risk Strat­e­gy to small cap stocks. Since 1997, Swan has suc­cess­ful­ly remained invest­ed in large cap com­pa­nies while mit­i­gat­ing the down­side risks via the intel­li­gent and effi­cient use of options. Con­cep­tu­al­ly, the Defined Risk Strat­e­gy can be applied to any asset class with an investable exchange trad­ed fund (ETF) and liq­uid enough options on the ETF, whether S&P 500, emerg­ing mar­kets, for­eign devel­oped mar­kets or oth­ers. Apply­ing the DRS to oth­er asset class­es is explored in detail in the recent white paper “Diver­si­fy­ing with the Defined Risk Strat­e­gy.”

No one knows what com­pa­nies or indus­tries might be born, evolve, or dom­i­nate our econ­o­my over the next ten or twen­ty years. Twen­ty years ago most peo­ple wouldn’t have been able to con­ceive of social media, the iPhone or Ama­zon Prime, yet today many peo­ple couldn’t imag­ine life with­out them. With small cap stocks, investors have ear­ly expo­sure to the lead­ers of tomor­row.

See how the Defined Risk Strat­e­gy is applied to U.S. Small Cap stocks or for more infor­ma­tion on the strat­e­gy call 970.382.8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout the author: Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.


Impor­tant Notes and Dis­clo­sures:

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non-qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970–382-8901 or 059-SGI-031516 

By |2018-10-09T17:04:14+00:00March 29th, 2016|Blog|Comments Off on Capturing the American Dynamism in US Small Cap Equity ETFs