Financial Education

“Are you suggesting that coconuts migrate?”

“Not at all - they could be carried.” (Monty Python and the Holy Grail)

Migration, when applied to a stock, typically refers to migration between categories in the size/style matrix: small caps become large, large caps become small, growth stocks become values and vice versa.

On average, small cap companies and “value” stocks tend to perform better than large-cap and growth stocks, even when adjusted by Beta. There is an ongoing academic debate over whether this is due to rational investors who recognize risk factors not captured by Beta, or whether there is an irrational preference for larger companies and growth relative to value.

In the May/June 2007 Financial Analysts Journal, Fama and French frame the issue by determining the sources of the excess return attributable to portfolio migration. The size premium is almost entirely due to small cap stocks that become large. The value premium is composed of three factors: value stocks for which growth accelerates; growth stocks for which growth slows; and the fact that value stocks tend to perform better than growth stocks of a given size.

Personally I don’t think the anomaly requires “rational pricing of a non-Beta risk” or irrational behavior. Even rational investors can make mistakes, defined here as inefficient pricing. Arnott has noted that the “mistakes” in small/large companies are mathematically more likely to be pricing them to be too small/large, particularly when indices are weighted by capitalization.

For more information, see all articles on: Investing in Stocks, Investment Returns, Research, Valuation

See also:

Selling Short

Shares Authorized, Issued and Outstanding

Price Weighted Index

Margin Transactions

Long-Short Investing