Does The Size Effect Exist? Probably. by Wesley R. Gray, Ph.D.
Executive Summary:
Case for NO Size Effect
The traditional small-minus-big value-adjusted long/short factor (SMB) developed by Gene Fama and Ken French has arguably added NO value over time. Performance over the past 30 years has been flat and highly volatile (1983-2013).
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
We create an extreme size value-adjusted factor (E-SMB), which is formed based on quintile splits on size (the original SMB factor is based on median splits). If size is a contributing factor to long-term returns, we should see an even larger premium associated with E-SMB.
The data say otherwise: our results show WORSE performance for E-SMB relative to SMB.
These baseline results question the validity of the “small-cap effect.”
Case for a Size Effect
But why has older research (e.g., Banz’s 1981 Journal of Finance Economics paper) identified a size effect? Turns out the the devil is in the details.
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What’s the bottomline?
Identifying a size effect depends on the methodology employed!
From the perspective of a buy and hold investor, the size effect is still alive and well.
Intuitively, there should be SOME premium to buying small cap stocks due to their limited liquidity and transparency relative to larger firms.
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The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
Summary Statistics VW (1/1927 to 4/2014)
- Small value has the strongest performance; SG-LG, SV-LV = Size Effect; LG-LV, SG-SV = Value Effect
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
Summary Statistics EW (1/1927 to 4/2014)
- Small value has the strongest performance; SG-LG, SV-LV = Size Effect; LG-LV, SG-SV = Value Effect
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
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Full article via Alpha Architect
