Size Effect

Do the stocks of small firms consistently outperform those of larger companies? If so, why, and can investors/traders exploit this tendency? These blog entries relate to the size effect.

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Big Three Factors across Countries

Are there parallels at the country stock market level of the size, value and momentum effects observed for individual stocks? In their January 2014 paper entitled “Value, Size and Momentum across Countries”, Adam Zaremba and Przemysław Konieczka investigate country-level value, size and momentum premiums. They measure these factors at the country level as:

  • Value (V): book-to-market ratio of country stocks aggregated via the weighting scheme used to construct the country stock index at the time of portfolio formation.
  • Size (S): total market capitalization of country stocks at the time of portfolio formation.
  • Long-Term Momentum (LTM): country index return during the 12 months before portfolio formation.
  • Short-Term Momentum (STM): country index return during the month before portfolio formation.

They calculate these factors using either MSCI equity indexes (47 indexes available at the beginning of the sample period) or local stock indexes (only 24 indexes available at the beginning of the sample period). They measure the country-level premium for each factor as the return on an equally weighted portfolio that is each month long (short) the 30% of countries with the highest (lowest) expected returns for that factor. They fully collateralize short sides with reserves in the risk-free rate. They also calculate a total market return as the capitalization-weighted average return across all country markets. They perform calculations separately in U.S. dollars, euros and yen. Using monthly firm/stock data for listed stocks as available within 66 countries from the end of May 2000 through November 2013, and contemporaneous Fama-French model U.S. factors, they find that: Keep Reading

Equity Investing Based on Liquidity

Does the variation of individual stock returns with liquidity support an investment style? In the January 2014 update of their paper entitled “Liquidity as an Investment Style”, Roger Ibbotson and Daniel Kim examine the viability and distinctiveness of a liquidity investment style and investigate the portfolio-level performance of liquidity in combination with size, value and momentum styles. They define liquidity as annual turnover, number of shares traded divided by number of shares outstanding. They hypothesize that stocks with relatively low (high) turnover tend to be near the bottom (top) of their ranges of expectation. Their liquidity style thus overweights (underweights) stocks with low (high) annual turnover. They define size, value and momentum based on market capitalization, earnings-to-price ratio (E/P) and past 12-month return, respectively. They reform test portfolios via annual sorts into four ranks (quartiles), with initial equal weights and one-year holding intervals. Using monthly data for the 3,500 U.S. stocks with the largest market capitalizations (re-selected each year) over the period 1971 through 2013, they find that: Keep Reading

Style Performance by Calendar Month

The Trading Calendar presents full-year and monthly cumulative performance profiles for the overall stock market (S&P 500 Index) based on its average daily behavior since 1950. How much do the corresponding monthly behaviors of the various size and value/growth styles deviate from an overall equity market profile? To investigate, we consider the the following six exchange-traded funds (ETF) that cut across capitalization (large, medium and small) and value versus growth:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.
iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.
iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.
iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.
iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.
iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

Using monthly dividend-adjusted closing prices for the style ETFs and S&P Depository Receipts (SPY) over the period August 2001 through December 2013 (150 months, limited by data for IWS/IWP), we find that: Keep Reading

Doing Momentum with Style (ETFs) Robustness/Sensitivity Tests

How sensitive is the performance of “Doing Momentum with Style (ETFs)” to selecting ranks other than winners and to choosing a momentum ranking interval other than six months? This strategy each month ranks the following six style exchange-traded funds (ETF) on past return and rotates to the strongest style:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.
iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.
iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.
iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.
iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.
iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

Available data are so limited that sensitivity test results may mislead. With that reservation, we perform two robustness/sensitivity tests: (1) comparison of returns for all six ranks of winner through loser based on a ranking interval of six months and a holding interval of one month (6-1); and, (2) comparison of winner returns for ranking intervals ranging from one to 12 months (1-1 through 12-1) and for a six-month lagged six-month ranking interval (12:7-1) per “Isolating the Decisive Momentum (Echo?)”, all with one-month holding intervals. Using monthly adjusted closing prices for the style ETFs and SPDR S&P 500 (SPY) over the period August 2001 through December 2013 (150 months), we find that: Keep Reading

Doing Momentum with Style (ETFs)

“Beat the Market with Hot-Anomaly Switching?” concludes that “a trader who periodically switches to the hottest known anomaly based on a rolling window of past performance may be able to beat the market. Anomalies appear to have their own kind of momentum.” Does momentum therefore work for style-based exchange-traded funds (ETF)? To investigate, we apply a simple momentum strategy to the following six ETFs that cut across market capitalization (large, medium and small) and value versus growth:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.
iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.
iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.
iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.
iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.
iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

The simple (6-1) strategy allocates all funds each month to the one style ETF with the highest total return over the past six months. A six-month ranking period is intuitively large enough to gauge style momentum but small enough to react to changes in business conditions that might favor one style over others. An alternative, more cautious strategy allocates at the end of each month all funds either to the style ETF with the highest total return over the past six months or to cash depending on whether the S&P 500 Index is above or below its 10-month simple moving average (6-1;SMA10). Using monthly adjusted closing prices for the style ETFs, the S&P 500 index, 3-month Treasury bills (T-bills) and S&P Depository Receipts (SPY) over the period August 2001 through December 2013 (150 months, limited by data for IWS and IWP), we find that: Keep Reading

Stock Markets Have Value and Size, Too?

Do country stock markets exhibit useful aggregate value and size metrics? In his December 2013 paper entitled “Macro Model for Macro Funds”, Adam Zaremba investigates whether macro size and value factors for country stock markets predict country stock index returns. Specifically, he calculates size and value factors at the country level in each of 66 countries. The size factor is the market capitalization of all listed firms in a country index. The value factor is the book-to-market value ratio (B/M) of all firms in a country index aggregated according to the index weighting methodology. He uses both MSCI country indexes and extant local country indexes to measure country market returns. He tests relationships between country-level size and value factors and future returns by each month separately constructing portfolios of the equally weighted top 30%, middle 40% and bottom 30% of country markets based on aggregate size and value factors. He also measures the performance of fully collateralized portfolios that are each month long (short) the equally weighted top (bottom) 30% of country markets based on aggregate size and value factors separately. To test sensitivity to the currency used, he performs all calculations separately in U.S. dollars, euros and yen. Using monthly accounting and return data as specified during June 2000 through November 2013, he finds that: Keep Reading

Value and Momentum Behaviors in Developed Markets

How do value and momentum interact with each other and with size, economic and liquidity factors worldwide? In the November 2013 version of their paper entitled “Size, Value, and Momentum in Developed Country Equity Returns: Macroeconomic and Liquidity Exposures”, Nusret Cakici and Sinan Tan address this question for developed markets. They use long-short, factor-sorted portfolios to measure size, value and momentum premiums. They consider future Gross Domestic Product (GDP) growth and future consumption growth as economic factors. They consider both funding liquidity (a potential indicator of investor margin cost, focusing on the difference between interbank lending rate and short-term deposit yield) and stock market liquidity (the estimated cost of trading stocks). Using monthly stock returns, firm accounting data and economic data for 23 developed countries during January 1990 through March 2012, they find that: Keep Reading

Measuring the Size Effect with Capitalization-based ETFs

Do popular capitalization-based exchange-traded funds (ETF) confirm the existence of a reliably exploitable size effect? To investigate, we compare the difference in equally weighted returns (small minus large) for the following matched pair of small-large ETFs:

  • iShares Russell 2000 Index (Smallcap) Index (IWM)
  • iShares Russell 1000 (Largecap) Index (IWB)

Using monthly adjusted closing prices (incorporating dividends) for these ETFs during May 2000 (the earliest month available for both) through October 2013 (162 months), we find that: Keep Reading

Turn of the Year and Size in U.S. Equities

The turn of the year (December-January) for the U.S. stock market includes the Santa Claus rally and the January effect. Some research indicates the latter is dead (and was driven essentially by small-capitalization stocks when alive). How does the stock market behave across the turn of the year for a recent sample? To check, we construct cumulative return profiles from 20 trading days before through 20 trading days after the end of the calendar year for the Russell 2000 Index, the S&P 500 Index and the Dow Jones Industrial Average (DJIA) since the inception of the Russell 2000 Index. Using daily and monthly levels of all three indexes from December 1987 through January 2013 (26 December and 26 January observations), we find that: Keep Reading

Mutual Funds Successfully Exploiting Academic Research?

Can equity funds exploit widely accepted stock return anomalies? In their July 2013 paper entitled “Academic Knowledge Dissemination in the Mutual Fund Industry: Can Mutual Funds Successfully Adopt Factor Investing Strategies?”, Eduard Van Gelderen and Joop Huij investigate whether mutual funds that materially adopt investment strategies based on published asset pricing anomalies consistently outperform the stock market. They first use monthly regressions to measure degrees of use of six factor investing strategies (low-beta, small cap, value, momentum, short-term reversal and long-term reversion) across U.S. equity mutual funds. They then calculate market-adjusted returns to determine whether funds employing the strategies outperform those that do not and the market. Using monthly returns for 6,814 U.S. equity mutual funds, and contemporaneous monthly returns for the specified factors, during 1990 through 2010, they find that: Keep Reading

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