Micro, small & large cap stocks

[zandrajohn]

In the FireCalc portfolio options we may choose "micro", "small" and "large" cap stocks. How does this split relate to the small, medium & large cap that I am more used to hearing about?
Thanks
JL

 

[ESRBob]

Zandrajohn,
"Micro=cap" is even smaller than small cap, and has historically provided even better diversification. These are generally pulled from around the smallest 4% of stocks in the NYSE and stocks from other exchanges with around that same market cap. "Small" in stock market parlance is not anything you and I would recognize as small, though. These are the smallest 10% or so of NYSE stocks, which tend to still be companies with thousands of employees, billions of dollars of revenue and so on. But again, historically, that is where great long-term appreciation has been found.

What you and I might think of as small stocks -- companies with $20-100 million of sales or a couple hundred to 500 employees, are really best thought of as private equity investments that you'd want to research that way -- thinking of them as illiquid, long-term holdings, trying to meet their management, get invited onto conference calls and so forth. In the full portfolio asset allocation in my book, I actually suggest people can constructively put up to 5% into that asset class as a way of even further diversifying -- the risks you take there are really different kinds of risks than overall market risk-- with returns tied to product, patents, management, market penetration, competitors etc to a larger degree.

Hope this helps,

 

[dory36]

Thanks ESRBob,

For those who don't know, the extra asset classes in FIRECalc are courtesy of ESRBob, who researched this information for his book Work Less, Live More, and graciously provided it for use in FIRECalc.

dory36

 

[zandrajohn]

ESRBob,
Thanks from me also; that was very helpful.
I am guessing that you are not too impressed with the "mi-cap" stocks that seem to be all the rage these days.
JL

 

[ESRBob]

There's certainly nothing wrong with mid-cap stocks, but they don't seem to offer sufficiently different risk and return characteristics from large caps to make them an interesting asset class for the slicer/dicer crowd. For that reason, you could hold US Midcaps and just count them as part of your US Large holding, if you were keen to have them.

At least in the good old days, US Small was sufficiently uncorrelated to US Large to make it a class to overweight in your portfolio. There is some discussion (in a recent WSJ article, for instance) that US Small is becoming more correlated to US Large in recent years, but we hope it will return to historic relationships again, even if that takes the form of having it start to tank as US Large takes off in the next few years.

The quest is always for quality asset classes that are relatively less-correlated to the traditional SP500/US Treasury asset classes.