These data illustrate 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 the size and value premiums. Note that the highest persistence is for the momentum premium.
Second, as we lengthen the time frame, the expected result begins to more clearly emerge. Over independent five-year periods, three of the four premiums are positive at least three-quarters of the time. We shouldn't interpret these numbers with too much precision, however, because 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. For instance, 65 percent and 76 percent of five-year periods result in positive size and value premiums, which means that large stocks outperform small stocks 35 percent of the time, and growth stocks outperform value stocks 24 percent of the time.
Another insight we can collect from the data set is just how frequently one of the four premiums was positive over monthly periods, and how frequently all were positive. This gives you a sense of the diversification benefits of having exposure to all four premiums instead of focusing on a single one, such as the market premium.
|At Least 1 Premium||All 4 Premiums|
|Positive Months (%)||96||10|
This second table shows that at least one premium was positive in 96 percent of the months. All four were positive in 10 percent of the months. Remember that the best consistency result we found in the first table was momentum, which was positive in only 64 percent of monthly periods. All else being equal, this indicates you should consider having exposure to a bit of each of these premiums for diversification purposes.
These examples demonstrate why I believe that knowledge is the armor necessary to protect you from confusing strategy with outcome. As Benjamin Franklin said, "An investment in knowledge pays the best interest."
Larry Swedroe is the director of research for the BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.