By |Published On: November 14th, 2013|Categories: Uncategorized|

First, a detailed analysis of the S&P 500 equal-weight index against the S&P 500 value-weight index from Jan 1963 through September 2013:

What drives the spread?

betas


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Many people assume the spread between EW and VW is a size premium, but this doesn’t tell the entire story.

Review the Asset Pricing Model module above (key stats highlighted).

This analysis represents the beta estimates for a variety of asset pricing models, which are used to control for different exposures on a portfolio. Rm-rf is the market-risk free spread; SMB is a L/S spread that captures small-stock exposure; HML is a L/S spread that captures value-stock exposure; and MOM is a L/S spread that captures momentum exposure.

Here is an explanation of how to calculate the various beta/alphas:
http://youtu.be/mrfWCUKX1Qw


The S&P 500 EW index has a fairly large exposure to the “value factor,” which suggests that the spread is driven by size, but also value! There is also a beta of 1.1, suggesting a slightly higher beta.

Below we look at the same analysis, but for the S&P 500 index. There is a beta of 1 (makes sense), a negative size factor (i.e., the value-weight index tilts large), and a roughly flat value exposure.

betasp500


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

On net, there is an approximate .32 point increase in the SMB beta and a .31 point increase in the HML beta between EW and VW S&P 500. A casual interpretation of these results is that the premium for the EW S&P 500 index is partially driven by a size premium, but also driven by a value premium.

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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