By Catherine Yoshimoto, director, product management
When US equity markets reached the bottom one year ago at the onset of the pandemic, US microcap stocks were dealt a particularly sharp blow. They subsequently rebounded alongside all US equity market cap segments, but their performance continued to lag their larger size segment counterparts—until the events of early 2021 when US microcaps soared above the rest.
Small but not insignificant
The Russell Microcap Index consists of the smallest stocks in the Russell 3000E Index, and represents less than 2% of its total market cap. But despite comprising just a small fraction of US equity markets, US microcaps have garnered growing attention from investors in recent years. US microcap assets under management have risen by 33% over the past five years, reaching $25 billion at the end of 2020.[1]
The potential for diversification benefits has been one of the key reasons behind the growth of microcap investing—particularly when it comes to portfolios with high allocations to large-cap stocks. As shown below, US microcaps have exhibited lower correlations to large and mega cap stocks over the past five years, offering the potential for added diversification.
The pandemic and the trough
Many investors have also sought microcaps for their alpha generation potential, but this was hardly a feature of US microcaps during the March 2020 market turmoil. While the early days of the pandemic took a widespread toll across US equities, microcap performance was hit hardest. As shown below, the Russell Microcap Index was down 43% year-to-date as of March 18, 2020—the most pronounced dip of any US equity size segment.
The Reddit trading craze and the peak
The graph above also demonstrates that not only did the Russell Microcap Index fare the worst during the March 2020 market downturn, but its YTD performance continued to lag other size segments through the end of the year. However, the events of early 2021 led to a significant reversal of fortune for US microcaps.
In January 2021, users on Reddit forums collaborated to buy shares and call options in companies where hedge funds had large short positions. The concerted effort was a success, and the phenomenon’s biggest target was Gamestop, a video game retailer whose market cap skyrocketed from $1.3 billion at the end of December to nearly $28 billion at the end of January. The stock’s dramatic rise not only bolstered Russell 2000 Index performance, but also gave a considerable boost to the Russell Microcap Index, contributing 259 basis points to its YTD performance as of March 19, 2021 and securing the spot of its largest holding by a longshot. (The stock itself was classified micro in late 2020.)
This time period marked a turning point for US microcaps, where its YTD 2021 performance surpassed all other size segments. As shown below, the recent surge has not only made the Russell Microcap Index the top YTD performer, but it’s also outperformed other US equity size segments for the trailing one-year period ending March 2021.
The relative performance can be observed in global equities as well, with the FTSE Global Micro Cap Index and FTSE Global Small Cap Index leading their large/mid counterpart FTSE All-World Index.
An eventful year in the rearview
It remains to be seen whether or the retail money events will endure. But what’s certain is they added another chapter to an already eventful one-year period for US microcaps—a chapter that materially altered the trajectory of their performance.
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[1] Source: eVestment, data reported as of February 15, 2021
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