Larry Swedroe: Size Premium Persists

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Random Walker
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Larry Swedroe: Size Premium Persists

Post by Random Walker » Mon Jan 29, 2018 10:57 am

http://www.etf.com/sections/index-inves ... nopaging=1

The title says it all. The article addresses reasons for the premium to have shrunk, reasons for it to persist, small growth anomaly. Reviews Asness article showing that controlling for quality restores the size premium. Looking forward, to me smaller companies are intuitively riskier, should have a higher cost of capital, and thus should have a higher expected return. Larry finishes the article emphasizing that size is a unique risk factor with low correlation to other factors, and thus should provide diversification benefit.

Dave

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Re: Larry Swedroe: Size Premium Persists

Post by hilink73 » Mon Jan 29, 2018 2:33 pm

Random Walker wrote:
Mon Jan 29, 2018 10:57 am
http://www.etf.com/sections/index-inves ... nopaging=1

The title says it all. The article addresses reasons for the premium to have shrunk, reasons for it to persist, small growth anomaly. Reviews Asness article showing that controlling for quality restores the size premium. Looking forward, to me smaller companies are intuitively riskier, should have a higher cost of capital, and thus should have a higher expected return. Larry finishes the article emphasizing that size is a unique risk factor with low correlation to other factors, and thus should provide diversification benefit.

Dave
Thanks for the link, Dave.
The explanation sounds intuitive for me.

I've tilted to small cap value, but not small cap only.

Does anybody here own IWC (iShares Microcap) (tracks Russell Microcap Index)?

Comparison to IJS (iShares S&P Small-Cap 600 Value ETF) and IJR (iShares S&P Small-Cap ETF):
https://www.portfoliovisualizer.com/bac ... ion4_1=100

Edit: corrected link above

Added:

Comparison against BRSIX (Bridgeway Ultra-Small Company Market), which is quite interesting.

https://www.portfoliovisualizer.com/bac ... ion4_1=100
Last edited by hilink73 on Mon Jan 29, 2018 3:33 pm, edited 4 times in total.

MikeMak27
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Re: Larry Swedroe: Size Premium Persists

Post by MikeMak27 » Mon Jan 29, 2018 3:13 pm

IJS is plenty small enough for me, and it has the beneficial screen for profitability. I would avoid any Russell index like the plague.
Mac 4 fund portfolio: 45% US small cap value (IJS, VBR), 40% Emerging Markets (IEMG, VWO, FPMAX), 10% long term US treasuries (TLT), 5% US REITS (VNQ)

Random Walker
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Re: Larry Swedroe: Size Premium Persists

Post by Random Walker » Mon Jan 29, 2018 3:40 pm

Hilink,
I too only have SCV and no small alone. I believe the size effect is greatest in the value companies. That fits with the small growth lottery black hole as well.

Dave

hilink73
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Re: Larry Swedroe: Size Premium Persists

Post by hilink73 » Mon Jan 29, 2018 3:49 pm

Random Walker wrote:
Mon Jan 29, 2018 3:40 pm
Hilink,
I too only have SCV and no small alone. I believe the size effect is greatest in the value companies. That fits with the small growth lottery black hole as well.

Dave
Yes.
I think BRSIX is out of reach for me as an US NRA, so I'll stick with IJS (iShares S&P 600 Value).

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Re: Larry Swedroe: Size Premium Persists

Post by MindTheGAAP » Mon Jan 29, 2018 3:55 pm

The one fund I have that is Small Cap without a value tilt is the TM Vanguard Small Cap Admiral Fund (VTMSX) which is smaller in terms of Mkt Cap versus the regular Vanguard Small Cap fund (VSMAX). Hold it in my Roth but figure I'm fine with it regardless because it tracks the S&P600 and no other Vanguard Fund does that for me.
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Re: Larry Swedroe: Size Premium Persists

Post by fennewaldaj » Mon Jan 29, 2018 5:57 pm

When I run factor regressions on vanguards small cap fund in portfolio visualizer it comes out slightly positive in the profitability investment and quality factors (which persist in there most recent index). I realize that they have no explicit quality screens but perhaps the fact most of these blackhole stocks don't make the indexes at all is the reason. Also at least currently vanguard excludes the bottom 2% of the market which is likely the part that needs the most screening.

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Re: Larry Swedroe: Size Premium Persists

Post by nisiprius » Mon Jan 29, 2018 7:21 pm

I don't think you can say X "persists" if you are allowed to change the definition of X.

Let's say backtesting no longer shows much of a premium for small-caps as originally defined. But we now know about a group of "black hole" stocks, a group that Banz didn't know about in 1981. In hindsight, we know that the black hole stocks have underperformed. Therefore, in hindsight, we know that a freshly-discovered, new class of stocks--small-caps-ex-black-holes, or SMEXBOLEs--has outperformed.

You can't say the small-cap premium has "persisted." because it isn't same as the SMEXBOLE premium. At this time, you can't say the SMEXBOLE premium has persisted, because it has only recently been identified. Starting now, we can keep records and find out whether the SMEXBOLE premium does persist, going forward, in the future.
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Re: Larry Swedroe: Size Premium Persists

Post by Alexa9 » Mon Jan 29, 2018 7:34 pm

The size premium to me is logical based on the sheer number of stocks in that category that are hidden gems and unknown for now. Most large caps are heavily traded and priced more accurately than small caps. Supposedly it is a small number of small caps that do exceedingly well that drive the premium.
The value premium is logical based on the stocks that people don't want. These are also hidden gems that are not priced accurately. It's a lot like buying 3,000 lottery tickets when you buy a small value fund. 5 or so of them should be winners over the long term. Unlike large caps where you're virtually guaranteed to win, but maybe not as big.

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Re: Larry Swedroe: Size Premium Persists

Post by Theoretical » Mon Jan 29, 2018 9:41 pm

MikeMak27 wrote:
Mon Jan 29, 2018 3:13 pm
IJS is plenty small enough for me, and it has the beneficial screen for profitability. I would avoid any Russell index like the plague.
Oddly enough, the key to fixing Russell indexs is to de-cap-weight them. The Pure Value indexes, the Russell Fundamental Large and Small and the various R1K factor indexes have actually been pretty sound and not had the negative alphas the cap weighted/front runnable ones have.

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Re: Larry Swedroe: Size Premium Persists

Post by Theoretical » Mon Jan 29, 2018 9:48 pm

Re: the Russells

Oddly enough, the key to fixing Russell indexs is to de-cap-weight them. The Pure Value indexes, the Russell Fundamental Large and Small and the various R1K factor indexes have actually been pretty sound and not had the negative alphas the cap weighted/front runnable ones have.

The Russell Fundamental ones are particularly good at that by reworking its index on exactly the same day as the Russell reconstitution and rebalancing only one quarter of the portfolio every quarter. It is quite literally designed to Front run its parent index, especially because the definition of large and small is not cap weighted either.

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Re: Larry Swedroe: Size Premium Persists

Post by sreynard » Mon Jan 29, 2018 10:04 pm

nisiprius wrote:
Mon Jan 29, 2018 7:21 pm
I don't think you can say X "persists" if you are allowed to change the definition of X.

Let's say backtesting no longer shows much of a premium for small-caps as originally defined. But we now know about a group of "black hole" stocks, a group that Banz didn't know about in 1981. In hindsight, we know that the black hole stocks have underperformed. Therefore, in hindsight, we know that a freshly-discovered, new class of stocks--small-caps-ex-black-holes, or SMEXBOLEs--has outperformed.

You can't say the small-cap premium has "persisted." because it isn't same as the SMEXBOLE premium. At this time, you can't say the SMEXBOLE premium has persisted, because it has only recently been identified. Starting now, we can keep records and find out whether the SMEXBOLE premium does persist, going forward, in the future.
Sniff, sniff, sniff? Do I detect the aroma of logic here?!? Isn't there a rule against that, or something? :twisted:

That all sounds great, but what's the ER on that SMEXBOLEs fund of yours, and do I have to buy it through an advisor? :wink:

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Re: Larry Swedroe: Size Premium Persists

Post by nedsaid » Mon Jan 29, 2018 10:06 pm

nisiprius wrote:
Mon Jan 29, 2018 7:21 pm
I don't think you can say X "persists" if you are allowed to change the definition of X.

Let's say backtesting no longer shows much of a premium for small-caps as originally defined. But we now know about a group of "black hole" stocks, a group that Banz didn't know about in 1981. In hindsight, we know that the black hole stocks have underperformed. Therefore, in hindsight, we know that a freshly-discovered, new class of stocks--small-caps-ex-black-holes, or SMEXBOLEs--has outperformed.

You can't say the small-cap premium has "persisted." because it isn't same as the SMEXBOLE premium. At this time, you can't say the SMEXBOLE premium has persisted, because it has only recently been identified. Starting now, we can keep records and find out whether the SMEXBOLE premium does persist, going forward, in the future.
I keep saying this, the well-constructed indexes like the S&P Indexes screen out the "black hole" stocks that everyone should hate. They screen out the "anti-factors" which is one reason indexing works so well, there already is some screening for quality. This is a big reason the S&P 600 Small-Cap Index held up so well during the 2000-2002 bear market, S&P requires that companies listed in their indexes actually have earnings. The speculative junk that got issued during the internet/high tech mania just were not in the good indexes. I recall that stock was being issued for companies that had no revenue, they would take the corporate shell of a dead company, give it a name that implied it was connected to high tech and/or the internet, and investors would show interest.
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Re: Larry Swedroe: Size Premium Persists

Post by sreynard » Mon Jan 29, 2018 10:17 pm

nedsaid wrote:
Mon Jan 29, 2018 10:06 pm
nisiprius wrote:
Mon Jan 29, 2018 7:21 pm
I don't think you can say X "persists" if you are allowed to change the definition of X.

Let's say backtesting no longer shows much of a premium for small-caps as originally defined. But we now know about a group of "black hole" stocks, a group that Banz didn't know about in 1981. In hindsight, we know that the black hole stocks have underperformed. Therefore, in hindsight, we know that a freshly-discovered, new class of stocks--small-caps-ex-black-holes, or SMEXBOLEs--has outperformed.

You can't say the small-cap premium has "persisted." because it isn't same as the SMEXBOLE premium. At this time, you can't say the SMEXBOLE premium has persisted, because it has only recently been identified. Starting now, we can keep records and find out whether the SMEXBOLE premium does persist, going forward, in the future.
I keep saying this, the well-constructed indexes like the S&P Indexes screen out the "black hole" stocks that everyone should hate. They screen out the "anti-factors" which is one reason indexing works so well, there already is some screening for quality. This is a big reason the S&P 600 Small-Cap Index held up so well during the 2000-2002 bear market, S&P requires that companies listed in their indexes actually have earnings. The speculative junk that got issued during the internet/high tech mania just were not in the good indexes. I recall that stock was being issued for companies that had no revenue, they would take the corporate shell of a dead company, give it a name that implied it was connected to high tech and/or the internet, and investors would show interest.
I think you missed the point Ned. To abuse the metaphor, he's talking about "black holes" that hadn't gone "super-nova" when the the index was formed. You can't just exclude them after the fact and say the original criteria still works. What's next? Next year we eliminate all stock symbols beginning with the letter 'C' and declare the small-value premium "persists"?!? :twisted:

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Re: Larry Swedroe: Size Premium Persists

Post by nedsaid » Tue Jan 30, 2018 8:49 pm

sreynard wrote:
Mon Jan 29, 2018 10:17 pm
nedsaid wrote:
Mon Jan 29, 2018 10:06 pm
nisiprius wrote:
Mon Jan 29, 2018 7:21 pm
I don't think you can say X "persists" if you are allowed to change the definition of X.

Let's say backtesting no longer shows much of a premium for small-caps as originally defined. But we now know about a group of "black hole" stocks, a group that Banz didn't know about in 1981. In hindsight, we know that the black hole stocks have underperformed. Therefore, in hindsight, we know that a freshly-discovered, new class of stocks--small-caps-ex-black-holes, or SMEXBOLEs--has outperformed.

You can't say the small-cap premium has "persisted." because it isn't same as the SMEXBOLE premium. At this time, you can't say the SMEXBOLE premium has persisted, because it has only recently been identified. Starting now, we can keep records and find out whether the SMEXBOLE premium does persist, going forward, in the future.
I keep saying this, the well-constructed indexes like the S&P Indexes screen out the "black hole" stocks that everyone should hate. They screen out the "anti-factors" which is one reason indexing works so well, there already is some screening for quality. This is a big reason the S&P 600 Small-Cap Index held up so well during the 2000-2002 bear market, S&P requires that companies listed in their indexes actually have earnings. The speculative junk that got issued during the internet/high tech mania just were not in the good indexes. I recall that stock was being issued for companies that had no revenue, they would take the corporate shell of a dead company, give it a name that implied it was connected to high tech and/or the internet, and investors would show interest.
I think you missed the point Ned. To abuse the metaphor, he's talking about "black holes" that hadn't gone "super-nova" when the the index was formed. You can't just exclude them after the fact and say the original criteria still works. What's next? Next year we eliminate all stock symbols beginning with the letter 'C' and declare the small-value premium "persists"?!? :twisted:
I have not missed the point at all. S&P does not screen for their indexes after the fact. We are not talking about looking back 10 years, identifying the losers, and calling them black holes. If a stock trades with no earnings and no revenue, that is a speculative black hole. You don't need backtesting to identify those. We are talking real time and not looking back.
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Re: Larry Swedroe: Size Premium Persists

Post by nisiprius » Tue Jan 30, 2018 8:58 pm

nedsaid wrote:
Mon Jan 29, 2018 10:06 pm
...I keep saying this, the well-constructed indexes like the S&P Indexes screen out the "black hole" stocks that everyone should hate...
I believe you, but if the normal indexes don't contain them, then what are the academics looking at?

Parenthetically, the Cowles Commission's 1938 study, that forms the basis of most "back to 1871" charts, did something similar. They chose not to include any data on stocks traded on the Curb Exchange, even though they represented about 15% of all stocks traded in the United States, because the Curb Exchange was so plagued by shenanigans that the newspaper that printed the stock prices actually warned about their not being reliable. So the Cowles "Common-Stock Indexes, 1871-1937" was throwing out a lot of questionable stocks... even back then.
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Re: Larry Swedroe: Size Premium Persists

Post by nedsaid » Tue Jan 30, 2018 9:27 pm

nisiprius wrote:
Tue Jan 30, 2018 8:58 pm
nedsaid wrote:
Mon Jan 29, 2018 10:06 pm
...I keep saying this, the well-constructed indexes like the S&P Indexes screen out the "black hole" stocks that everyone should hate...
I believe you, but if the normal indexes don't contain them, then what are the academics looking at?

Parenthetically, the Cowles Commission's 1938 study, that forms the basis of most "back to 1871" charts, did something similar. They chose not to include any data on stocks traded on the Curb Exchange, even though they represented about 15% of all stocks traded in the United States, because the Curb Exchange was so plagued by shenanigans that the newspaper that printed the stock prices actually warned about their not being reliable. So the Cowles "Common-Stock Indexes, 1871-1937" was throwing out a lot of questionable stocks... even back then.
You could ask Larry, but the academics I think are looking at everything. I will say that buying the S&P 600 Small-Cap Index ETF was one of the very best investment decisions I ever made. My insurance company did an analysis of my portfolio and said that I needed more Small-Caps. So I bought some. Had no idea that this was such a great index. I could have bought the Russell Small-Cap Index which has been panned as being a bad index. Didn't know what I was doing and I did something right.

If at first you try and don't succeed, blame the index. Or as I have often said, do the Groucho Marx solution and switch indexes. I know Vanguard does.
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Re: Larry Swedroe: Size Premium Persists

Post by nisiprius » Tue Jan 30, 2018 9:41 pm

nedsaid wrote:
Tue Jan 30, 2018 9:27 pm
...I will say that buying the S&P 600 Small-Cap Index ETF was one of the very best investment decisions I ever made. My insurance company did an analysis of my portfolio and said that I needed more Small-Caps. So I bought some. Had no idea that this was such a great index. I could have bought the Russell Small-Cap Index which has been panned as being a bad index. Didn't know what I was doing and I did something right.

If at first you try and don't succeed, blame the index. Or as I have often said, do the Groucho Marx solution and switch indexes. I know Vanguard does.
I'm impressed.

Blue, VTWO, tracking the Russell 2000.
Orange, VIOO, tracking the S&P Small-Cap 600. And just for laughs
Green, VOO, tracking the S&P 500, and
Yellow, VB, tracking whatever Vanguard's mainstream small-cap fund tracks.

Their standard small-cap fund basically matched the S&P 500; the S&P Small-Cap 600 outperformed both of them; while the Russell 2000 underperformed both of them.

Source

Image
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Re: Larry Swedroe: Size Premium Persists

Post by golfCaddy » Tue Jan 30, 2018 9:43 pm

If you look at Vanguard funds over the past 25 years, which roughly matches when Fama published his seminal paper, Vanguard's small cap fund out-performed the S&P 500 by about 55 basis points a year before fees. The small premium did persist, but it was low and by far, the bigger determinant of your return would have been your ratio of stocks to bond and US to international.

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Re: Larry Swedroe: Size Premium Persists

Post by nedsaid » Thu Feb 01, 2018 8:26 pm

nisiprius wrote:
Tue Jan 30, 2018 9:41 pm
nedsaid wrote:
Tue Jan 30, 2018 9:27 pm
...I will say that buying the S&P 600 Small-Cap Index ETF was one of the very best investment decisions I ever made. My insurance company did an analysis of my portfolio and said that I needed more Small-Caps. So I bought some. Had no idea that this was such a great index. I could have bought the Russell Small-Cap Index which has been panned as being a bad index. Didn't know what I was doing and I did something right.

If at first you try and don't succeed, blame the index. Or as I have often said, do the Groucho Marx solution and switch indexes. I know Vanguard does.
I'm impressed.

Blue, VTWO, tracking the Russell 2000.
Orange, VIOO, tracking the S&P Small-Cap 600. And just for laughs
Green, VOO, tracking the S&P 500, and
Yellow, VB, tracking whatever Vanguard's mainstream small-cap fund tracks.

Their standard small-cap fund basically matched the S&P 500; the S&P Small-Cap 600 outperformed both of them; while the Russell 2000 underperformed both of them.

Source

Image
Russell 2000, bad bad index. S&P 600, a great index. Seriously, I have read from several sources that the Russell 2000 is not a very good Small-Cap Index and your graph confirms that. You can also see what I was talking about. Some guy on Morningstar talked about this, once you do some screening for quality, the Small-Cap premium returns with a vengeance. I guess Russell doesn't screen out the "anti-factors." I know, I know, I watched too much Star Trek.
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Re: Larry Swedroe: Size Premium Persists

Post by Theoretical » Thu Feb 01, 2018 11:14 pm

Here's how good from a factor standpoint the S&P 600 is (the relevant time is 1/1/2006, when they changed to a multi valuation structure and a different set of factors on the growth side.

The Value Index is basically a slightly less tilted first cousin of the much more robust (in theory) DFA fund. Factor analysis proves it out by having the same size loads, slightly less value (as defined by P/B), and a greater quality load, while having neutral momentum.

Where it gets really crazy is the growth index, which has a persistent moderate Value and Momentum tilt. The S&P 600 is absolutely a spectacular index.

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Re: Larry Swedroe: Size Premium Persists

Post by Bimmer » Fri Feb 02, 2018 12:11 am

Two questions:

(1) When I compare the performance of Vanguard Mid-Cap ETF VO to Small Index ETF IJS, the performance is extremely similar. Why doesn't anyone talk about Larry's unloved mid-caps anymore? The majority of my stock portfolio is split between Total Market (VTI) and Fidelity Extended Market (FSEMX, due to what is available in 401Ks), with some VO in taxable as well. Seems like no more premium to going smaller than mid-caps or the extended market index.

(2) When I research S&P 600 Small-Cap Indexes I notice that Vanguard's ETF VIOO has a 0.15% expense ratio, but the mutual fund (VSMSX) has an expense ratio of 0.08%. Why is this? Seems backwards. Why would anyone buy the ETF?

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Re: Larry Swedroe: Size Premium Persists

Post by Nate79 » Fri Feb 02, 2018 12:59 am

Bimmer wrote:
Fri Feb 02, 2018 12:11 am
Two questions:

(1) When I compare the performance of Vanguard Mid-Cap ETF VO to Small Index ETF IJS, the performance is extremely similar. Why doesn't anyone talk about Larry's unloved mid-caps anymore? The majority of my stock portfolio is split between Total Market (VTI) and Fidelity Extended Market (FSEMX, due to what is available in 401Ks), with some VO in taxable as well. Seems like no more premium to going smaller than mid-caps or the extended market index.

(2) When I research S&P 600 Small-Cap Indexes I notice that Vanguard's ETF VIOO has a 0.15% expense ratio, but the mutual fund (VSMSX) has an expense ratio of 0.08%. Why is this? Seems backwards. Why would anyone buy the ETF?

-Bimmer
Have you tried to place an order for VSMSX?

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Re: Larry Swedroe: Size Premium Persists

Post by david1082b » Fri Feb 02, 2018 3:15 am

Bimmer wrote:
Fri Feb 02, 2018 12:11 am
(2) When I research S&P 600 Small-Cap Indexes I notice that Vanguard's ETF VIOO has a 0.15% expense ratio, but the mutual fund (VSMSX) has an expense ratio of 0.08%. Why is this? Seems backwards. Why would anyone buy the ETF?
Minimum investment: $5,000,000 https://advisors.vanguard.com/VGApp/iip ... undId=1845

VSMSX is Institutional Shares class. You get a decent discount for buying in bulk, like Admiral Shares but for slightly higher rollers.

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Re: Larry Swedroe: Size Premium Persists

Post by Bimmer » Fri Feb 02, 2018 12:50 pm

Well, that explains that about expense ratios! I will try to place an order today and see how far I get!

What about the mid-cap vs small-cap question?
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Re: Larry Swedroe: Size Premium Persists

Post by Bimmer » Fri Feb 02, 2018 2:58 pm

BTW, I think I attributed wrong - it's Mel's Unloved Mid-Caps!
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Re: Larry Swedroe: Size Premium Persists

Post by nisiprius » Fri Feb 02, 2018 3:20 pm

golfCaddy wrote:
Tue Jan 30, 2018 9:43 pm
If you look at Vanguard funds over the past 25 years, which roughly matches when Fama published his seminal paper, Vanguard's small cap fund out-performed the S&P 500 by about 55 basis points a year before fees. The small premium did persist, but it was low and by far, the bigger determinant of your return would have been your ratio of stocks to bond and US to international.
Yes and no. One of my quibbles with the "small-is-beautiful" faction is that they rarely are clear as to they are merely claiming a higher return, or whether they are actually claiming a higher risk-adjusted return.

In your example, over the last 25 years NAESX (red, Vanguard Small-Cap Index) had a higher return than VFINX (blue, Vanguard 500 Index Fund), yes, but it had a higher standard deviation, too--and a lower Sharpe ratio. Although it had a higher return, the higher return wasn't adequate compensation for the higher risk.

Source
Image

Now, the original Banz paper did seem to be making some kind of claim. It is only phrased in backward-looking terms, but I think the people who created small-cap funds and got everyone interested in small-caps must have expected persistence:
In 1981, Rolf Banz wrote:This study examines the empirical relattonship between the return and the total market value of NYSE common stocks. It is found that smaller firms have had htgher risk adjusted returns, on average, than larger lirms. This ‘size effect’ has been in existence for at least forty years and is evidence that the capital asset pricing model is misspecified.
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Re: Larry Swedroe: Size Premium Persists

Post by carguyny » Fri Feb 02, 2018 4:19 pm

Asness' least favorite factor is size, quote from a recent interview with CNBC:

"Gotta love the market factor. My favorite [among] the others is still the value factor. It has the best story," he said. "My least favorite is the small-cap factor. Evidence is weaker than the other ones. And the story, why should small beat large? It is a risk or illiquidity story."

https://www.cnbc.com/2017/11/03/top-wal ... sting.html

I'm not sure this is actually change in view, when it comes to implementing in actual portfolios, he recommended combing his Momentum fund with DFLVX (DFA U.S. Large Cap Value from Dimensional Fund Advisors) back in 2012.

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