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John Authers

The Size Effect Didn't Disappear. It Never Existed

The more academics searched for proof that small companies tend to beat bigger ones after adjusting for risk, the less they found.

Small is no longer beautiful in the investment zoo.

Small is no longer beautiful in the investment zoo.

Photographer: GEORG WENDT/DPA/Getty Images

The academic hunt for investment factors, which can predict that certain stocks will tend to outperform in the long run, has turned into something of an arms race. A generation ago, academics identified three factors that more or less everyone agreed worked to some extent — momentum (winners keep winning while losers keep losing); value (cheap stocks beat expensive ones); and size (small companies tend to beat bigger ones). There was a long and turgid debate over whether these factors could really all be explained in terms of risk, which would need to be rewarded in the long run, or whether they showed persistent irrationalities or anomalies in the market. 

Things have moved on. Academics now claim to have identified more than 400 factors (which makes it a wonder that anyone ever failed to beat the market). Meanwhile, doubts over the “small is beautiful” theory have reached such a point that many question whether it exists at all.