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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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Doubling Down on Size

“Is There Really an Size Effect?” summarizes research challenging the materiality of the equity size effect. Is there a counter? In their June 2018 paper entitled “It Has Been Very Easy to Beat the S&P500 in 2000-2018. Several Examples”, Pablo Fernandez and Pablo Acin double down on the size effect via a combination of market capitalization thresholds and equal weighting. Specifically, they compare values of a $100 initial investment at the beginning of January 2000, held through April 2018, in:

  • The market capitalization-weighted (MW) S&P 500.
  • The equally weighted (EW) 20, 40, 60 and 80 of the smallest stocks in the S&P 1500, reformed either every 12 months or every 24 months.

All portfolios are dividend-reinvested. Their objective is to provide investors with facts to aid portfolio analysis and selection of investment criteria. Using returns for the specified stocks over the selected sample period, they find that:

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Style Performance by Calendar Month

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 May 2018 (202 months, limited by data for IWS/IWP), 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.

We test a simple Top 1 strategy that allocates all funds each month to the one style ETF with the highest total return over a set momentum measurement (ranking or lookback) interval. We focus on the baseline ranking interval from “Simple Asset Class ETF Momentum Strategy”, but test sensitivity of findings to ranking intervals ranging from one to 12 months. As benchmarks, we consider an equally weighted and monthly rebalanced combination of all six style ETFs (EW All), buying and holding S&P Depository Receipts (SPY), and holding SPY when the S&P 500 Index is above its 10-month simple moving average and U.S. Treasury bills (T-bills) when the index is below its 10-month simple moving average (SPY:SMA10). We consider the performance metrics used in “Momentum Strategy (SACEMS)”. Using monthly dividend-adjusted closing prices for the style ETFs and SPY, monthly levels of the S&P 500 index and monthly yields for 3-month T-bills during August 2001 (limited by IWS and IWP) through May 2018 (202 months, ), we find that:

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Is There Really an Size Effect?

Do small market capitalization stocks really outperform big ones, as strongly implied by the prominence of the size effect in published research and factor models? In their May 2018 paper entitled “Fact, Fiction, and the Size Effect”, Ron Alquist, Ronen Israel and Tobias Moskowitz survey the body of research on the size effect and employ simple tests to assess claims made about it. Based on published and peer-reviewed academic papers and on tests using data for U.S. stocks and equity factor premiums, international developed and emerging market stocks and stock indexes, U.S. bonds and various currencies as available through December 2017, they find that: Keep Reading

Ziemba Party Holding Presidency Strategy Update

“Exploiting the Presidential Cycle and Party in Power” summarizes strategies that hold small stocks (large stock or bonds) when Democrats (Republicans) hold the U.S. presidency. How has this strategy performed in recent years? To investigate, we consider three strategy alternatives using exchange-traded funds (ETF):

  1. D-IWM:R-SPY: hold iShares Russell 2000 (IWM) when Democrats hold the presidency and SPDR S&P 500 (SPY) when Republicans hold it.
  2. D-IWM:R-LQD: hold IWM when Democrats hold the presidency and iShares iBoxx Investment Grade Corporate Bond (LQD) when Republicans hold it.
  3. D-IWM:R-IEF: hold IWM when Democrats hold the presidency and iShares 7-10 Year Treasury Bond (IEF) when Republicans hold it.

We use calendar years to determine party holding the presidency. As benchmarks, we consider buying and holding each of SPY, IWM, LQD or IEF and annually rebalanced portfolios of 60% SPY and 40% LQD (60 SPY-40 LQD) or 60% SPY and 40% IEF (60 SPY-40 IEF). We consider as performance metrics: average annual excess return (relative to the yield on 1-year U.S. Treasury notes at the beginning of each year); standard deviation of annual excess returns; annual Sharpe ratio; compound annual growth rate (CAGR); and, maximum annual drawdown (annual MaxDD). We assume portfolio switching/rebalancing frictions are negligible. Except for CAGR, computations are for full calendar years only. Using monthly dividend-adjusted closing prices for the specified ETFs during July 2002 (limited by LQD and IEF) through April 2018, we find that:

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Simple Volatility-Payout-Momentum Stock Strategy

Is there an easy way for investors to capture jointly the most reliable stock return factor premiums? In their March 2018 paper entitled “The Conservative Formula: Quantitative Investing Made Easy”, Pim van Vliet and David Blitz propose a stock selection strategy based on low return volatility, high net payout yield and strong price momentum. Specifically, at the end of each quarter they:

  1. Segment the then-current 1,000 largest stocks into 500 with the lowest and 500 with the highest 36-month return volatilities.
  2. Within each segment, rank stocks based on total net payout yield (NPY), calculated as dividend yield minus change in shares outstanding divided by its 24-month moving average.
  3. Within each segment, rank stocks based on return from 12 months ago to one month ago (with the skip-month intended to avoid return reversals).
  4. Within the low-volatility segment, average the momentum and NPY ranks for each stock and equally weight the top 100 to reform the Conservative Formula portfolio.
  5. Within the high-volatility segment, average the momentum and NPY ranks for each stock and equally weight the bottom 100 to reform the Speculative Formula portfolio.

Limiting the stock universe to the top 1,000 based on market capitalization suppresses liquidity risk. Limiting screening parameters to three intensely studied factors that require no accounting data mitigates data snooping and data availability risks. They focus on the 1,000 largest U.S. stocks to test a long sample, but also consider the next 1,000 U.S. stocks (mid-caps) and the 1,000 largest stocks from each of Europe, Japan and emerging markets. They further examine: (1) sensitivity to economic conditions doe the long U.S. sample; and, (2) impact of trading frictions in the range 0.1%-0.3% for developed markets and 0.2%-0.6% for emerging markets. Using quarterly prices, dividends and shares outstanding for the contemporaneously largest 1,000 U.S. stocks since 1926, European and Japanese stocks since 1986 and emerging markets stocks since 1991, all through 2016, they find that:

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Measuring the Size Effect with Capitalization-based ETFs

Do popular capitalization-based exchange-traded funds (ETF) offer a reliable way to exploit an equity size effect? To investigate, we compare the difference in returns (small minus big) between:

  • iShares Russell 2000 Index (Smallcap) Index (IWM), and
  • SPDR S&P 500 (SPY)

Using monthly dividend-adjusted closing prices for these ETFs during May 2000 (limited by data for IWM) through February 2018 (214 months), we find that: Keep Reading

Technical Trading of Equity Factor Premiums

Do technical trend trading/intrinsic momentum strategies work for widely used equity factors such as size (small minus big market capitalizations), value (high minus low book-to-market ratios), profitability (robust minus weak), investment (conservative minus aggressive) and momentum (winners minus losers)? In their January 2018 paper entitled “What Goes up Must Not Come Down – Time Series Momentum in Factor Risk Premiums”, Maximilian Renz investigates time variation and trend-based predictability of these five factors and the market factor. He first constructs price series for the six long-short factor portfolios. He then considers seven rules based on a short simple moving average (SMA) crossing above (bullish) or below (bearish) a long SMA measured in trading days: SMA(1, 20), SMA(1, 40), SMA(1, 120), SMA(1, 180), SMA(1, 240), SMA(20, 180) and SMA(20, 240). He also considers two intrinsic (absolute or time series) momentum rules based on change in price over the past 180 or 240 trading days (positive bullish and negative bearish). Motivated by prior research by others, he focuses on SMA(1, 180), daily price crossing its 180-day SMA. He measures trend-based statistical predictability of factor premiums and investigates economic value via a strategy that levers factor exposures between 0 and 1.5 using trend-based signals. Finally, he examines whether incorporating trend information improves accuracies of 1-factor (market), 3-factor (adding size and value) and 5-factor (further adding profitability and investment) models of stock returns. Using daily returns for the six selected U.S. stock market equity factors and for 30 industries during July 1963 through December 2015, he finds that: Keep Reading

Categorization of Risk Premiums

What is the best way to think about reliabilities and risks of various anomaly premiums commonly that investors believe to be available for exploitation? In their December 2017 paper entitled “A Framework for Risk Premia Investing”, Kari Vatanen and Antti Suhonen present a framework for categorizing widely accepted anomaly premiums to facilitate construction of balanced investment strategies. They first categorize each premium as fundamental, behavioral or structural based on its robustness as indicated by clarity, economic rationale and capacity. They then designate each premium in each category as either defensive or offensive depending on whether it is feasible as long-only or requires short-selling and leverage, and on its return skewness and tail risk. Based on expected robustness and riskiness of selected premiums as described in the body of research, they conclude that: Keep Reading

Are Equity Multifactor ETFs Working?

Are equity multifactor strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider seven ETFs, all currently available (in order of decreasing assets):

  • Goldman Sachs ActiveBeta U.S. Large Cap Equity (GSLC) – holds large U.S. stocks based on good value, strong momentum, high quality and low volatility.
  • iShares Edge MSCI Multifactor USA (LRGF) – holds large and mid-cap U.S. stocks with focus on quality, value, size and momentum, while maintaining a level of risk similar to that of the market.
  • John Hancock Multifactor Large Cap (JHML) – holds large U.S. stocks based on smaller capitalization, lower relative price and higher profitability, which academic research links to higher expected returns.
  • JPMorgan Diversified Return U.S. Equity (JPUS) – holds U.S. stocks based on value, quality and momentum via a risk-weighting process that lowers exposure to historically volatile sectors and stocks.
  • iShares Edge MSCI Multifactor International (INTF) – holds global developed market ex U.S. large and mid-cap stocks based on quality, value, size and momentum, while maintaining a level of risk similar to that of the market.
  • John Hancock Multifactor Mid Cap (JHMM) – holds mid-cap U.S. stocks based on smaller capitalization, lower relative price and higher profitability, which academic research links to higher expected returns.
  • Xtrackers Russell 1000 Comprehensive Factor (DEUS) – seeks to track, before fees and expenses, the Russell 1000 Comprehensive Factor Index, which seeks exposure to quality, value, momentum, low volatility and size factors.

Because available sample periods are very short, we focus on daily return statistics, along with cumulative returns. We use four benchmarks according to fund descriptions: SPDR S&P 500 (SPY), iShares MSCI ACWI ex US (ACWX), SPDR S&P MidCap 400 (MDY) and iShares Russell 1000 (IWB). Using daily returns for the seven equity multifactor ETFs and benchmarks as available through early October 2017, we find that: Keep Reading

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