NEW YORK — Opportunities to find value are shrinking for active domestic small-cap equity managers.
An increasing number of small-cap equity analysts, combined with the groundswell in the number of hedge funds that are actively seeking inefficiently priced small-cap stocks, have made it more difficult in recent years for small-cap equity managers to find value.
That's a far cry from the famous "three-factor model" developed by Eugene Fama and Kenneth R. French in 1992. That model is a mathematical formula developed to determine the expected return of an asset or portfolio. One of the cornerstones of the formula, which was an extension of William Sharpe's Capital Asset Pricing Model, was that the cheapest stocks could be found in the small-cap value universe.
Many financial professionals attribute the fact that the cheapest stocks can be found in the small-cap value universe to the efficient market hypothesis, a theory created by Mr. Fama in 1965. Put simply, stock prices generally are where they should be, and because there is generally less available information on small-cap stocks than large-cap because fewer analysts cover small-cap stocks, more cheap prices can be found in the small-cap arena.
Now, however, that is getting to be less and less the case, according to industry experts. A new survey from Financial Dynamics Inc., a New York investor relations and research firm which surveyed the top broker/dealers on Wall Street, found that the number of sell-side small-cap equity analysts has increased since 2001.