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rob carrick

Smart financial planning ranges further than merely mixing stocks and bonds.Andrey Popov

The book on small cap stocks is that they offer more risk with the potential for better returns than blue chips.

The reality over the past 10 years for small-capitalization stocks is more risk and worse returns. Investors did far better with blue chips than with smaller companies. Until global economic growth moves sustainably higher, this trend is likely to continue.

As a proxy for big blue chips, we'll use the S&P/TSX 60 index. For speculative small stocks, we'll use the S&P/TSX small cap index. Over the 10 years to May 31, the small cap index delivered a compound average annual total return of 0.5 per cent while the 60 index made 4.1 per cent. In the 12 months to May 31, the small cap index made 8.7 per cent and the 60 index gained 13.6 per cent. The first five months of the year have seen the Canadian market cool off, but the 60 index still managed a 1.8-per-cent gain over this period. The small cap index lost 4.6 per cent.

Here's another perspective on what a drag small caps have been. The Vanguard FTSE Canada All Cap Index ETF (VCN) includes small and medium stocks as well as large caps, while the Vanguard FTSE Canada Index ETF (VCE) skews to larger stocks. The theory behind the all cap index is that it should outperform thanks to its small cap component, but that's not happening. VCE averaged 5.1 per cent over the past three years, compared to 4.4 per cent for VCN.

Weak resource prices explain a lot what's troubling small caps. The small cap index is almost 50 per cent weighted to energy and materials, compared to about 31 per cent for the 60 index. Dividends are another area where small and large caps differ. If you invested in the 60 index through the iShares S&P/TSX 60 Index ETF (XIU), you'd have a dividend yield of about 2.7 per cent. The yield on the iShares S&P/TSX Small Cap Index ETF is 1.8 per cent.

Small caps will have their day, probably when commodity prices break out. But how much pain will you have to endure before this happens? Remember, many global stock markets have done very well in the past few years and concern about a correction is rising. When markets do correct, expect small caps to be hit harder than those steady blue chips.