There’s a battle going on in the markets that’s likely having a run-off effect on your mutual fund portfolio. It’s the age-old David and Goliath story and, like the fable, care to guess who’s winning?

For the past five years, small-cap stocks have been quietly but successfully muscling their way past many of the bigger, brawnier companies that underpin the markets. And unlike some fights that have to be decided by judges, this match can be settled strictly by the numbers. So here they are. Over the past five years, small caps have averaged an annual compound return of 17.35%, large caps have posted a respectable 13.2%, and the stalwart blue chips have brought up the rear with 10.45% 1

Bigger is not always better

There’s a lot to be said about the momentum and growth potential of smaller-cap stocks. As the numbers demonstrate, there’s a compelling case to be made that many investors might benefit with mutual funds drawn from across the market-cap spectrum.

Indeed, one of the biggest benefits of mutual funds is just how easy it is to give your portfolio a little taste of everything from micro-caps to the so-called mega-caps. By embracing this diversity, not only are you enhancing your opportunities for long-term growth, but you’re also broadening your exposure, reducing overall risk, and putting yourself in position to benefit from a variety of economic scenarios.

3 reasons to think small

Here are three key reasons to consider including small-cap funds in your portfolio.

1. Strength on the upside and a cushion on the downside. Small, well-managed companies tend to have more upside potential than larger ones. If your portfolio includes mutual funds with holdings from both sides of the spectrum, you can benefit from the up-and-comers as well as tried-andtrue dividend payers. Not only can this enhance returns, it can mitigate the impact of dramatic swings from either side.

2. Merger and acquisition opportunities. As smaller companies begin to grow, they become targets for takeovers by larger companies. This benefits the firms themselves and investors who have mutual funds with exposure to the companies on both sides of the transaction.

3. Management style diversification. Growth and value as fund management styles can be closely linked to the market cap of the securities they hold. Growth fund managers typically buy securities they believe will experience faster-than-average growth, whether from revenue, earnings, or cash flow. Value funds typically seek out “diamonds in the rough” — that is, undervalued stocks priced lower than their fundamentals would suggest is reasonable. Almost by definition, small-cap funds tend to follow a growth approach while blue-chip funds tend to fall into the value category. By adding a domestic or international mid-cap fund to the mix, we can harness a “best of all worlds” approach in your portfolio.

Markets in Canada, the U.S. and overseas are ripe with both exciting start-ups and market stalwarts. We’d be happy to review your portfolio’s holdings of domestic and foreign equity funds to make sure it’s harnessing all the potential possible from across the market-cap spectrum.

1 NASDAQ, S&P 500, & DOW Total Return Indices compounded annual return over the five years ended August 4, 2015. Source: Bloomberg.