Size Matters, if You Control Your Junk

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This is a new research paper published on January 22nd 2015 that studies the return of stocks based upon the size (defined in multiple ways).  What was done differently than other studies, was that the authors used a Quality and Junk variable to apply to the data.  The result was that smaller firms outperformed larger firms in the stock market if the portfolio was controlled with the QMJ (Quality Minus Junk) factor.  Meaning that a lot of the smaller companies were “junk” but the ones that were of quality outperformed the market.

The Authors:

Clifford S. Asness – AQR Capital Management, LLC

Andrea Frazzini – AQR Capital Management, LLC

Ronen Israel – AQR Capital Management, LLC

Tobias J. Moskowitz – University of Chicago – Booth School of Business

Lasse Heje Pedersen -New York University (NYU) – Department of Finance; Copenhagen Business School; AQR Capital Management, LLC; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

You can Download the Paper from the website here, or I have it posted on this site here.


One interesting finding was that a lot of the return of small companies resulted in the month of January:

One of the biggest challenges researchers pose to any interpretation of the size effect is that it mostly resides in January. Table 1 showed that all of the returns to SMB and the decile size spread are concentrated in January, with no evidence of any size effect outside of January

In Conclusion:

Size matters – and, in a much bigger way than previously thought – but only when controlling for junk. We examine seven empirical challenges that have been hurled at the size effect – that it is weak overall, has not worked out of sample and varies significantly through time, only works for extremes, only works in January, only works for market-price based measures of size, is subsumed by illiquidity, and is weak internationally – and systematically dismantle each one by controlling for a firm’s quality. The previous evidence on the variability of the size effect is largely due to the volatile performance of small, low quality “junky” firms. Controlling for junk, a much stronger and more stable size premium emerges that is robust across time, including those periods where the size effect seems to fail; monotonic in size and not concentrated in the extremes; robust across months of the year; robust across non-market price based measures of size; not subsumed by illiquidity premia; and robust internationally. These results are robust across a variety of quality measures as well.

One has to remember that this is more of an academic study, so real world results can be different when trying to apply the method.  Read the paper to understand in more detailed as to what is used to determine size, quality, junk and other measures.  However, I think this paper helps clarify for individual investors that concentrating on small companies (microcaps, smallcaps) can be a source of advantage and produce market beating returns.  I believe that this is true, but it takes more work to find the quality from the junk.

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