Random Walker wrote: ↑Sat Nov 03, 2018 11:40 am
I believe all the factors are stronger in small stocks: value stronger in small, momentum stronger in small, profitability stronger in small. People have argued whether or not there is a risk premium associated with size. I believe there is. Whether there is or not though, one could rationally tilt to size for the sake of possible risk premium and likely strength of the other factors in small.
Dave
In addition Dave, the factors seem to work better if you pair them with Quality. Small Cap works better and Value works better. This is why I like the S&P 500 Indexes, they screen for Quality to a degree. A Morningstar expert noted that the Small Cap effect has gone away except when you use a good Small Cap Index like the S&P 600 Small Cap Index, with a good index the Small Cap effect returns with a vengeance.
Quality is mainly in the Large Cap Growth area of the market but it seems to consist of the "right" growth stocks, pretty much strong balance sheets and consistency of earnings are the key. Momentum is also largely a Large Growth phenomenon, it exists in other parts of the Morningstar Stylebox but smaller stocks are often not liquid enough to effectively short.
Dimensional Fund Advisors also found that Value works better if you set Momentum to neutral, Value is associated with negative Momentum. So pairing factors often seems to help.
There is also a paradox here. Value works but so does Quality and Momentum which are associated with Growth stocks. Low Volatility often outperforms the market but only when it is in the Value sector but Low Vol has a bit of Quality in there as well.
I have often discussed the "anti-factors" which are the lottery stocks on the Growth side and the Value traps on the Value side. Even if you screen a bit for Quality on the Small Growth sector, results improve even for the "black hole" of investing. The better indexes screen out a lot of the junk, so I argue that in many cases indexing screens a bit for Quality. One reason that Vanguard Small Value Index and Vanguard Small Growth Indexes have such similar performance records.
My thesis is that the better indexes screen out the junk and one reason indexing works so well. Active investing "works" to the degree that managers can capture the factors and to the degree that fees are low enough to not eat up the excess performance. Active management often fails because the fees are just too high.
A fool and his money are good for business.