How Micro-Caps Add Value to a Small-Cap Value Strategy

Historically, micro-cap companies have been well represented in our Small Cap Value Strategy. The exposure, we believe, makes intuitive sense: We seek to provide investors with both the liquidity of larger small-caps and the dynamism of micro-caps. As detailed in this piece, historical returns, risk, liquidity, and the current market environment provides further context to our approach.

Historical Micro-Cap Returns

Over time, micro-caps have outperformed equities in all other capitalization ranges. In our view, this makes a compelling case for the inclusion of micro-cap names in a diversified portfolio. The chart below shows the long-term outperformance of micro-caps versus other small-, mid- and large-cap stocks. The data reflects the total return of a hypothetical investment in each capitalization range from 1990 through December 31, 2019.

Hypothetical Growth of One Unit from 12/31/1990 to 12/31/2019

Heartland Value Fund Portfolio Manager Perspective Growth Chart

Source: Kenneth R. French, ©2020 Center for Research in Security Prices, the University of Chicago Booth School of Business, 12/31/1990 to 12/31/2018
This is a hypothetical example for illustrative purposes only and does not represent the returns of any particular investment.
Past performance does not guarantee future results.

Many small-cap managers tend to gravitate toward the larger end of the market-cap spectrum, where information and liquidity are more readily available. In the micro-cap range, information is more scarce and liquidity less abundant. Generally, there are several analysts following the average company in the Russell 2000® Value. In contrast, smaller stocks are often ignored by brokerages and investment reports are scarce. The limited availability of information creates inefficiencies and provides an opportunity for investors willing to dig deeper. The lack of coverage, we believe, also causes many small-cap equity managers to stay away from micro-caps, which helps explain why they behave differently than larger small-caps.

Diversification Benefits

The table below illustrates correlations among stocks in four capitalization ranges. Returns on micro-caps have historically had a 0.73 correlation to large-caps, while mid-caps have tracked very closely to large-caps at 0.90. With a lower correlation this table suggests there is a benefit to including micro-caps in a broadly diversified portfolio.

Heartland Value Fund Portfolio Manager Perspective Cap Ranges Correlations Chart

Source: Kenneth R. French© and CRSP, 12/31/1990 to 12/31/2019

Favorable Upside/Downside Capture Ratio

Further analysis of the return profile by size shows additional benefits from the smallest stocks. The upside/downside capture ratio measures the relative participation in up markets versus that in down markets. A reading above 100% is favorable, indicating that up-market participation is greater. While micro-caps have shown the highest volatility compared with other capitalization ranges, in the context of this upside/downside measure they possessed the most favorable return dynamics.

Heartland Value Fund Portfolio Manager Perspective Upside Downside Table

Source: Kenneth R. French© and CRSP, 12/31/1990 to 12/31/2019

In our view, micro-caps often have more in common with private equity investments than other publicly traded stocks. For example, the biggest payoffs from micro-caps often occur upon the sale or merger of a holding. Similar to private equity, they also require longer holding periods to fully reap the benefits of the asset class. However, they have the advantage of being far more liquid than most alternative investments. We believe many investors do not realize the “quasi-alternative” characteristics of micro-caps.

Liquidity Considerations

Long-term return and correlation characteristics clearly suggest how micro-caps can benefit a portfolio. In the short or intermediate term, some caution is wise because micro-caps are more volatile and less liquid relative to their larger counterparts. This liquidity constraint can sometimes be a concern for institutional investors who may be wary of causing price movements when buying or selling micro-caps in quantity. We attempt to mitigate this through the way we manage the portfolio.

Balanced Approach

Our familiarity with the risks and rewards in the space is evident in our portfolio construction. The Small Cap Value portfolio generally includes more micro-cap names than larger small-cap names. But individual weights of the smallest names are typically reduced in an effort to mitigate the effects of constrained liquidity. This barbell approach helps moderate the volatility of the micro-cap space and is advantageous from the standpoint of liquidity.

Our Investment Philosophy

We apply our time-tested 10 Principles of Value Investing™ when evaluating micro-caps and our research is further enhanced by our more than 30 years of selecting companies in the asset class. Our long history of uncovering opportunities among some of the smallest publicly traded names provides us with expertise to thoroughly evaluate balance sheets and management—two elements we believe are key to successfully navigating the space. Our experience selecting micro-cap investments, we believe, gives us a clear competitive advantage relative to other small-cap managers.

The 10 Principles of Value Investing™

The 10 Principles™ provide a robust framework to assess any security. Internally generated fundamental research is particularly important in the micro-cap space, as coverage by the sell-side is often lacking and low trading volumes make it a time consuming process to build or liquidate a position. On this latter point, investors in micro-caps must be confident enough to be owners of the stock for an extended period. Such confidence, in our view, can only come from a proven research process. Heartland has faithfully applied the 10 Principles of Value Investing™ since the Firm’s founding in 1983.

Thoughts on Current Market Dynamics

Over the past several years, micro-caps’ performance relative to small-caps has fluctuated. Given the market turbulence that followed the financial crisis of 2008, that is not surprising. We believe the popularity of index funds, which reward larger names regardless of valuation, has prevented many micro-cap stocks from realizing their potential. The upshot has been a frustrating market in the near-term but a fertile hunting ground for investors committed to the space. Many of the smallest companies are niche players that specialize in unique industries where competition is limited. They are able to grow faster than larger diversified companies that trade at higher valuations. As sales growth becomes scarce in an aging expansion, we believe investors will rediscover the importance of organically driven results, which will lead to a rediscovering of micro-caps.

Please wait while we gather your results.


Bill Nasgovitz

Nasgovitz is Chairman and Portfolio Manager of the Value Fund and its corresponding separately managed account strategy. He has 52 years of industry experience, 38 at Heartland.

Small Cap Value Strategy Quick Links



Download PDF



View Commentary

Attribution & Contribution Reports

Sign In



Sign In


Email Sign Up


©2021 Heartland Advisors | 790 N. Water Street, Suite 1200, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

Past performance does not guarantee future results.

Investing involves risk, including the potential loss of principal.

There is no guarantee that a particular investment strategy will be successful.

Diversification does not eliminate the risk of experiencing investment losses. 

Small- and micro-cap investment strategies, which emphasize the significant growth potential of small companies, have their own unique risks and potential for rewards and may not be suitable for all investors. Small- and micro-cap securities are generally more volatile and less liquid than those of larger companies.

Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.

The statements and opinions expressed in the articles or appearances are those of the presenter. Any discussion of investments and investment strategies represents the presenters' views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true.

Economic predictions are based on estimates and are subject to change.

This paper utilizes data sourced from Kenneth R. French based on original stock data Derived from the US Stock Database ©2020 Center for Research in Security Prices (CRSP), the University of Chicago Booth School of Business and includes all equity securities listed on NYSE, Amex, NASDAQ and NYSE Arca that existed during the time period. We utilized monthly and annual value-weighted total returns of US stocks separated into ten market quintiles with 1 representing the largest and 10 representing the smallest. Large- cap stocks are defined as those in quintiles 1 and 2, mid-cap stocks are defined as those in quintiles 3 through 5, small-cap stocks are defined as those in quintiles 6 through 8 and micro-cap stocks are defined as those in quintiles 9 and 10. Market cap portfolios are formed and rebalanced annually.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap®, small-cap by the Russell 2000®, mid-cap by the Russell Midcap®, large-cap by the Russell Top 200®.

Heartland’s investing glossary provides definitions for several terms used on this page.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, Inc., a federally registered investment advisor. ALPS Distributors, Inc., is not affiliated with Heartland Advisors, Inc.