- Title: FACTOR BASED INVESTING: THE LONG TERM EVIDENCE
- Authors: ELROY DIMSON, PAUL MARSH, AND MIKE STAUNTON
- Publication: THE JOURNAL OF PORTFOLIO MANAGEMENT, 2017, SPECIAL ISSUE (version here)
What are the research questions?
- Is there out-of-sample (OOS) evidence for factor investing?
What are the Academic Insights?
By studying a data set including 23 countries and over a long time frame (1926 for the US and 1955 for the UK and on average 43 years for other countries), the authors find:
- The concept of the size effect was introduced by Banz (1981) documenting a monthly 1% premium of small cap stocks compared to large cap stocks. The authors find a diminished premium: 0.32% monthly for the longest average period and 0.45% monthly from 2000 to 2016.
- The concept of the value effect was introduced by Rosenberg et al. (1985) documenting a yearly 4% premium of value stocks compared to growth stocks. The authors find a diminished premium: 2.1%% yearly for the longest average period and 2.5% yearly from 2000 to 2016. Additionally, they warn that the value premium can come in erratic patterns. (see here for more info)
- The concept of the momentum effect was introduced by Jegadeesh and Titman(1993) documenting a monthly 1% premium of past winning stocks compared to past losing stocks. The authors find a fairly consistent premium: 0.71% monthly for the longest average period and 0.79% monthly from 2000 to 2016.
Why does it matter?
In general, the issue of data-mining may contaminate the statistical results from backtesting that underlie factor investing. The use of out-of-sample universes to test results obtained with US-only data sets is an important advance in testing the robustness of various factors and the associated return performance.
- Based on this research, the size premium is lower than originally thought. However, after considering the risks, illiquidity and transaction costs of investing in small-cap stocks, there at least seem to be no case to underweight them.
- The value premium has been lower in the US than originally documented. Outside the US, it is stronger and more persistent.
- With the caveat that momentum premium can go through periods of substantial underperformance and drawdowns, it (in the words of the authors) “can generate a disturbingly large abnormal return.”
The Most Important Chart From the Paper: