Small caps tend to be riskier than large companies. They have a greater potential for growth and offer higher returns, especially in the long term, but they don’t have the resources of companies with high capitalization, which makes them more vulnerable to adverse events and bearish sentiment. This Vulnerability is manifested in the instability of small-cap companies, which historically was higher than that of companies with high capitalization. They are particularly risky investments during the economic downturn, as they are not as well equipped than companies with a high capitalization to cope with dramatically decreasing demand.
When volatility is high, yields investors greatly depends on the average rate of return they expect, making a real income more difficult to predict and potentially make investment more risky. For example, from 1997 to 2012, the Russell 2000 index (small companies) returned 8.6% yoy compared to 4.8% for the s &P 500 (consisting mainly of large companies). In the same period, the Russell 2000 is about a third higher volatility.
In the period from 2003 to 2013, the volatility of small cap funds measured by the standard deviation was 19.28. For large cap funds, it was 15.54. (During the same period, small cap funds gave an average annual return of at 9.12%, and large cap funds yielded a return of 7.12%.) In short, this means that the return of the small cap funds varied from its average by 19.28 percentage points 68% of the time, and the return of large cap funds varied from its average by 15.54 percentage points 68% of the time. The higher variability of small cap funds reflect the higher volatility.
Companies with high capitalization, typically a safer investment, especially during the economic downturn of the business cycle because they are much more likely to weather changes without significant damage. This makes them more attractive to investors, attracting a steady stream of capital, which contributes to their volatility low.
On the other hand, large companies do not have the growth potential of small capitalization companies, as their size allows them to be quickly changing directions and new opportunities; the more resources that pillow them can also be a burden. Because they are more nimble, small caps may have more chances and take advantage of events and trends. This in turn leads to their historically higher return on investment than the big guys.