FRM Part II · FRM Exam Part II · Factor Theory
A portfolio manager at a pension fund notes that over long samples, small-capitalisation stocks have earned higher average returns than large-capitalisation stocks, even after adjusting for market beta. Which style factor is the manager describing?
The manager is describing the size factor. It reflects the historical tendency of small-capitalisation stocks to earn higher beta-adjusted returns than large-cap stocks, typically built as a small-minus-big portfolio. Momentum, quality and low volatility rely on different sorting characteristics, not market capitalisation.
- ASizeCorrect
- BMomentum
- CQuality
- DLow volatility
Explanation
The size factor captures the return difference between small-cap and large-cap stocks, often built as small minus big (SMB). Momentum concerns past winners versus losers, quality concerns profitability and earnings stability, and low volatility concerns stocks with low risk. Only size matches the description of market capitalisation based outperformance.
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