More and more, a few mega-cap companies dominate the US stock market performance. Financial journals come up with different names for those stocks every few years. They are now called the “Magnificent Seven”, but we all remember FAANG, right? Naturally, several questions arise – Is the current status quo, when the stock market capitalization is highly concentrated among the few extremely large companies, an exception or rule over history? And what’s the impact of this concentration on the performance of the one particular factor – the Size premium? We present the research paper written by Emery and Koëter that tries to answer those questions. 

We have brought attention to the importance of evaluating factors models in different market regimes, and now, we will take a closer look at the size factor. Size [SMB (small minus big)] factor is a popular investment choice for asset investigation by many portfolio managers worldwide. The Size earned prominence in Fama and French’s three and five-factor models, and enjoy the continued discussion about its place in today’s portfolio construction. But it’s crucially important for investors seeking to capture the Size premium to realize that it is dependent on the monetary policy being pursued by the Federal Reserve, as the monetary easing seems to induce a Size premium.

Numerous new businesses are emerging related to autonomous traffic, clean energy, biotechnology, etc. Without any doubt, these new companies look promising and at least the technology behind them seems to be the future. Moreover, this novel trend is also supported by the most prominent index creators S&P and MSCI. Both providers have created numerous thematic indexes connected to these hot industries. The popularity has caused that ETFs are nowhere behind, and as a result, these thematic indexes could be easily tracked. However, popularity itself does not guarantee the best investment, and we should be interested in these indexes in greater detail. A vital insight provides the novel research paper of Blitz (2021). The findings are interesting – the thematic investors bet against quantitative investors or, more precisely, against the most common factors that are well-known from the asset pricing models.

Equity factors are not as straightforward as they may seem to be. There is an ongoing debate about their usability or expected return since they have a cyclical nature. Moreover, the modern trend of smart beta only fuels this debate. Novel research by Blitz and Hanauer examines the size factor and sheds some light on this elusive anomaly. The size seems to be weak as a stand-alone factor, but it’s far from useless. The academic paper suggests that the size factor can be an important addition to the other equity factors as it helps to unlock the full potential of the quality, value or momentum factors.

Authors: Blitz, David and Hanauer, Matthias Xaver

Title: Settling the Size Matter