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Scientific Beta defends the Size factor's role in multi-factor portfolios following AQR note

Scientific Beta
·2-min read

Press Release - Boston, London, Nice, Paris, Singapore, Tokyo, Oct. 13, 2020

Scientific Beta defends the Size factor's role in multi-factor portfolios following AQR note

Scientific Beta focuses on the question of practical relevance: does the size factor add value to an investor's portfolio?

After AQR published a note on its website1 entitled: "There Is No Size Effect: Daily Edition", Scientific Beta has produced a short note, "The Size Factor Still Has Its Place in Multi-Factor Portfolios," questioning the relevance of AQR's conclusions.

AQR stress their previous view that the size factor does not exist, with their results showing that size does not have a premium when accounting for the market factor. In particular, they estimate the intercept in a time-series regression of size factor returns onto the market factor return. They find that augmenting the set of independent variables with the lagged market return in addition to the contemporaneous market return leads to an insignificant size premium.

Scientific Beta questions whether this result has any practical relevance for investors. Instead, Scientific Beta focuses on the question of practical relevance: does the size factor add value to an investor's portfolio?

When taking into account other potential factor exposures in a portfolio, apart from the market factor, adding the size factor improves the risk/return characteristics of the portfolio. Size is a strong diversifier of other traditional factors and consequently adds value to a multi-factor portfolio. Analysis that fails to take exposures to factors such as momentum or profitability into account is of little practical relevance to investors.

Furthermore, claiming that there is no size effect is contrary to the various academic asset pricing models that conclude that the size factor adds explanatory power in the cross-section of returns. These models, by including factors other than the market, provide meaningful conclusions for investors.

The Scientific Beta note and the related paper published in the Journal of Index Investing in winter 2019 can be accessed through the links below:

The Size Factor Still Has Its Place in Multi-Factor Portfolios, Scientific Beta, October 2020

Size Factor in Multifactor Portfolios: Does the Size Factor Still Have Its Place in Multifactor Portfolios? Winter 2019, Journal of Index Investing

1 https://www.aqr.com/Insights/Perspectives/There-is-No-Size-Effect-Daily- Edition

Scientific Beta is an original initiative which aims to favour the adoption of the latest advances in smart beta design and implementation by the whole investment industry. Its academic origin provides the foundation for its strategy: offer, in the best economic conditions possible, the smart beta solutions that are most proven scientifically with full transparency of both the methods and the associated risks.
Scientific Beta, 1 George Street, #15-02, Singapore 049145. For further information, please contact: contact@scientificbeta.com, Web: www.scientificbeta.com.

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