On the topic of SCV, there are in my mind two questions, that I'll attempt to address:
- Has Small Cap Value been arbitraged away, either by hedge funds or by a wave of money in "smart beta" products rushing in
- If Small Cap Value has not been arbitraged away, why not? Over what time horizons should one expect underperformance?
If the Small Cap Value premium has been arbitraged away, why has it underperformed? The following is from Yardeni charts:
I see underperformance, not an arbitraged premium.
The second thing I found interesting recently was in a recent interview of David Swensen, the Yale endowment manager, at the Council on Foreign Relations
Q: My name is Bhakti Mirchandani. I work at a hedge fund called 1 William Street.
You mentioned the damaging effects of short-termism for companies and for markets. And the way you’ve addressed that with Yale’s endowment is to invest largely in longer-term assets. But what about publicly traded companies? Unilever, for example, has stopped quarterly reporting. Other companies have stopped giving quarterly guidance, which is unique to the United States. But what steps would make you most optimistic about publicly traded companies and their investability from a long-termism perspective?
SWENSEN: You know, I think it’s possible to take a long-term approach with publicly traded companies. We have some managers that are engaged in public-securities investing in markets around the world. And in each of our relationships, the managers invest with a long time horizon. I think it gives them an enormous advantage.
If you can invest with a three- to five-year horizon, which is a pretty, pretty difficult thing to do—it might sound like it’s an easy thing to do if market conditions are benign, but you throw a 2008 or a 2009 in there and you have to really work hard to remember that this is temporary and that you need to keep on looking out three to five years when you’re making these decisions.
Ultimately, that, I think, is an incredibly powerful advantage. And the people that are on the quarter-to-quarter timeframe, they’re going to lose almost certainly. And they’re definitely going to be losing to the managers that are using the three- to five-year horizon. So I do know that it’s possible to extend your time horizon and succeed.
If Swensen thinks that it is a "pretty, pretty difficult thing to do" to invest with a long time horizon. Given that these factors often undergo stretches of performance that are at a minimum this long it seems strange to argue that managers have sent the premiums to zero through more efficient pricing. In conclusion, I find the several explanations for why SCV is an investing style of the past which will no longer yield excess returns to be self-contradictory.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."