Excerpt
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.
In their paper, Simpson and Grossmann (Sep 2022) make many calls to the research of Asness et al. (2018). They use the classification of subsamples for evaluation of size factors as the “Golden Age” (1957-1979), the “Embarrassment” period (1980-1999), and the “Resurrection” period (2000-2012), which helps to bring some light into when the Size is performing the best. Basically, they find that without controlling for Quality, there is a size effect in the Golden Age and the Resurrection period but not in the Embarrassment period. After controlling for firm Quality, however, they document a significant Size premium in all three periods. But is that really? And what may be the underlying forces behind these occurrences?
While nodding to previous research and acknowledging it, the authors challenge it and partly disagree while offering a demonstration that the size premium re–emerges whether or not one controls for Quality if one examines the monetary policy stance and stringency being followed by the Federal Reserve. Functions of monetary policy and liquidity in markets are the most important for these smaller companies that enjoy loosened financial conditions, cheap capital, and credit. In every period and subperiod, they find significant premiums for the SMB factor during periods of monetary easing with and without controlling for firm Quality; while there are no observations of significant premiums for the SMB factor during any period of monetary tightening, even if one controls for Quality.
We can conclude that choosing Quality among smaller firms during restrictive monetary periods and conditions will probably not contribute to and secure fine results. It would be 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.
Authors: Marc William Simpson and Axel Grossmann
Title: The Resurrected Size Effect Still Sleeps in the (Monetary) Winter
Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4228692
Visit Quantpedia for the full article https://quantpedia.com/size-factor-vs-monetary-policy-regime/.
Disclosure: Interactive Brokers
Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from Quantpedia and is being posted with its permission. The views expressed in this material are solely those of the author and/or Quantpedia and Interactive Brokers is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Join The Conversation
If you have a general question, it may already be covered in our FAQs. If you have an account-specific question or concern, please reach out to Client Services.