INTERNATIONAL. Small-cap stocks have historically offered the best risk-reward potential to investors, while gold has offered the worst, a research note released this week shows.

Richard Bernstein, chief investment strategist at Banc of America Securities-Merrill Lynch wrote: "Regardless of time horizon, small stocks offered the best."

Using various metrics that measure the likelihood of negative returns over various time periods, small caps—or those with market capitalization rates below US$2 billion—outperformed every other asset class since 1970.

Instead of defining risk as the standard deviation of returns,  Bernstein defined it as the percentage of the historical returns that were negative. If an asset provided a negative return during 5 of 25 periods studied, the risk measure would be 20%.

In addition to the findings about smaller companies, the research also shed light that will be welcome to the buy-and-hold believers: Over any given 10-year period, the chance for investors to lose money was minimal.

Bernstein says longer time horizons tend to reduce the probability of losing money in an investment, although gold appeared to be an exception.

He said: “Gold was the only asset class that generated a significant proportion of negative returns over 10-year periods."

"With the exception of gold, investors had little chance of losing money in our selected asset classes over ten-year time periods," Bernstein said. "Only in the current bear market did many equity benchmarks generate their first trailing 10-year losses for the periods we analyzed."

He did add caution about the strategy: The chances to lose money over long periods actually increased with technology, telecomm and utilities.

Outside the small-cap space, Bernstein found that financials provided the best risk/return in the S&P 500 over three- and five-year time horizons since 1990, even as the sector has deteriorated since the bank crisis began.

Hedge funds have been the most conservative strategy over the same time period, even though they brought a negative return for January 2009, while Treasurys had never lost money in that time.

"As attractive as large caps stocks were in the 1990s is as unattractive as they have been so far during the 2000s," Bernstein wrote. "Gold has so far won the performance derby despite being off more than 10% from its March 2008 high."

"It's definitely where you want to be when you have a long-term horizon," said Adriana Posada, portfolio manager of the American Beacon Small Cap Value Fund. "But it tends to be a pretty rough ride."

"What investors have forgotten is your asset allocation, while it should be long-term, needs to be reviewed periodically," Posada said. "We were complacent thinking that the market would just go up and up and up. I think we have to go back to that basic premise."

“Investors often lose sight of longer-term historical investment results, especially during short-term periods of extreme volatility and trending markets," Berstein added.

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