Including smaller company equities in your portfolio can result in better returns over the long term and diversification. Developed market smaller company stocks, in particular, can be more closely correlated with the economy of the country where they are listed, whereas large-cap stocks are typically more aligned with the global economy. This is the case with the FTSE 100 index, which is composed of the UK’s largest companies. These derive around 66 per cent of their revenues from outside the UK, while smaller UK companies tend to derive most of their revenues from the UK.
The size of a company can help determine whether it has a chance of beating the market average. Other factors, known as 'risk premia', include value (buying underpriced stocks) and momentum (buying the stocks that have recently risen the most). Table 1 shows how these various factors have performed over the past 20 years, and being small has delivered returns significantly ahead of other risk premia.