When I say style factor research I am thinking about things like value, size and momentum which over the years have been identified as explaining or predicting some of the excess returns delivered by certain stocks or groups of stocks. I reported recently on some research which reviewed the case for momentum, which if you missed it can be accessed by clicking on the highlighted momentum link above.
While today I thought I would share with you some more research which I read recently which was new to me and suggestive of a new unrecognised factor which is distinct from value, size and momentum. This is not new research as it was produced a few years back, but I only came across it recently, so apologies if you are already familiar with it.
So what it this unrecognised factor? Well it is liquidity and it has be researched thoroughly by Roger G. Ibbotson et al in two papers. The first one explores Liquidity as an Investment Style in which the authors:
"present comprehensive evidence in support of giving liquidity equal standing to size, value/growth, and momentum as investment styles, as defined by Sharpe (1992). First,we show that financial market liquidity, as identified by stock turnover, is an economically significant indicator of long-term returns. Then, we show that liquidity,as a characteristic, is not merely a substitute for size, value, and/or momentum. Finally,we show that liquidity has historically been a relatively stable characteristic of stocks, and that changes in liquidity are associated with changes in valuations."
The second paper By Roger G. Ibbotson & Wendy Hu - explores Liquidity Styles and Strategies in
U.S., International, and Global Markets in which the authors say:
"Liquidity is a strong predictor of future returns in U.S., International, and global markets, yet distinct from size, value, and momentum. We develop a strategy for implementing the liquidity style, creating portfolios that have positive and significant alphas, low betas, and good down-side protection geographically across all markets."
In this report they measure liquidity as measured by the annual share turnover (the sum of the twelve monthly volumes divided by each month’s shares outstanding). There was also a good interview with Ibbotson where he explains the background to the research and why it works. In essence you would be buying neglected out of favour stocks, presumably on the cheap which then get re-rated as they become…
