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Consistency of Stock Return Premiums

I’ve blogged previously on numerous stock market return premiums. In this post I’ll be exploring the consistency of the market, size, value and momentum premiums using U.S. stock market data (from Dartmouth Professor Ken French’s Web site) over the period of 1927–2011. Consistency is important because it gives you a sense of how frequently the unexpected happens: bonds outperforming stocks or growth outperforming value.


The first table below shows the consistency of each return premium over monthly, annual and independent five-year periods.

This table illustrates a number of points. First, over monthly periods, all of the return premiums are positive more often than they are negative, but it’s not much better than a coin flip for any of the four other than the momentum premium. Second, as we lengthen the time frame, the expected result begins to more clearly emerge. Over independent five-year periods, all of the premiums are positive in at least seven out of 10 periods. We shouldn’t interpret these numbers with too much precision, however, since there are only 17 independent five-year periods over this sample.
Nevertheless, directionally, we see that time horizon matters. Finally, the table gives one an appreciation of the tracking error relative to the stock market associated with the size and value premiums. While 71 and 76 percent of five-year periods result in positive size and value premiums, this means that large stocks outperform small stocks and growth outperforms value roughly 25 percent of the time.
The other data point I examined was how frequently one of the four premiums was positive over monthly periods and how frequently all were positive. This gives you a sense for the diversification benefits of having exposure to all four premiums instead of focusing on a single one like the market premium.

The “One Premium” column is a pretty amazing result. Remember that the best consistency result we found in the first table was that momentum was positive in 64 percent of monthly periods. However, at least one of the four premiums is positive in 96 percent of monthly periods. All else equal, this is saying you should have exposure to a bit of each of these premiums for diversification purposes.
Random Links and Commentary of the Week
Radiohead opened this season of Austin City Limits. Check it out here. Highlights for me were “Myxomatosis” and “Paranoid Android.”
I’ve been listening to Alec Baldwin’s “Here’s the Thing” podcast and enjoyed this episode with George Will.
Jared Kizer is the director of investment strategy for BAM Advisor Services. See our disclosures page for more information.


The MOM premium

What do you believe is the best way to gain exposure to the momentum premium today? AQR? DFA seems to have a position, as of now, that capturing it is too expensive and indirectly captures it through thoughtful trading.

at 10/17/2012 12:16 AM

Re: The MOM premium

At this point, in the mutual fund space AQR and Bridgeway are the only firms that I know of that have stock strategies in the market explicitly focused on capturing the momentum premium.

I think it's still somewhat of an open question as to whether the premium survives transaction costs but personally I think that it does. For example, if you go to Ken's site and calculate the momentum premium in small stocks and large stocks on an annual basis it's been 11.3% in small and 8.2% in large.

Let's focus specifically on large caps and assume that a long-only fund focused on capturing the momentum premium can capture 30% of the 8.2%, or 2.5% on a before costs basis. Even with a fairly high degree of turnover I would think that in large caps you wouldn't have transactions costs of 2.5%.

Now, whether it survives both taxes and transaction costs is a trickier question and I'm less sure about that one.

at 10/17/2012 10:43 AM

Well done !


Very much enjoyed and appreciated your artical, the "Consistency Stock Premium Returns", we need far more of this substantive rehetoric. We need to get this sort of information more widely disseminated.

Stephen Winks
at 10/18/2012 10:12 AM

Low Beta Stocks

Great information Jared. What about the low vol premium? Or is this just value in disguise?
at 12/6/2012 1:20 PM

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