Hey, just saw that paper.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4016481
It is about how to weight your portfolio. I back tested it for micro caps and small caps, not much success, so I stay with my equal weighted portfolios.
BUT:
The above shows, that if you exclude micro caps (on the 3 or 5 factor model of Fama and French) your performance gets killed.
It is beyond me why the authors say, they need to be excluded: “big portfolios cannot trade them because of trading costs”.
Well, what about that a ton of people do not have a big portfolio and that they might be able to trade micro caps?
I am trading them since 2011 and I can assure you, that even pretty conservative slippage calculations by portfolio123.com (for the microcaps I am trading up to 3% slippage, e.g. 6% for a round trip!!!) are realistic or can be beaten.
So, the argument that you need to exclude them in any case is simply wrong. You need to exclude them if you have a big account (dollar wise). Even then you could trade one micro cap portfolio with a smaller account and the rest in big caps.
You should not exclude them if your account is small enough to have not a price impact which leads to slippage costs that kills your performance (e.g., overcompensate the advantage of micro caps).
And: factors (value, momentum, quality, volatility, eps momentum, industry momentum) work great, but they even work much better in the micro-cap sphere!
THIS is the most important of my blog!
I know that I am not really nice here, because the cost of doing this is investing 10h a week for 2-5 years to get there. But I think the reward is bigger than trying to jump in a pool full of sharks that have tons of PHDs under their umbrella and competing with them (hint: they got so much capital that they will not compete with you in the micro to small cap space!).
I am not saying here that a small account cannot be an advantage in very liquid instruments because there you can also have a big advantage just because you do not have a big price impact.
But on all costs, make sure you use the advantages of your small account if you are a trader (fine to be an investor and cost average into the SPY, do not get me wrong here!).
Market:
Scared as hell, I sniff out a rally but will stay the course. Still hedged with 35% short of the Russel 2000 and long with the rest on small cap value momentum.
And the more I think about it: This does not look like 2008. I just cannot see Armageddon here. Still: the market is weak enough to be hedged. Looks like 2018 or 2011 to me.
Interesting links:
Have a great time!
Could you please give more advice on *how* you trade the Microcaps? Would would be minimum liquidity and on those with a large spread (>2% between bid & ask, perhaps with small shares available) do you just target the ask with a limit order and leave it, or hit mid market, or buy and hope for a fill?
Yes, thanks very much. Also if you don't mind, is the percentage of your Russell 2000 hedge something that you calculate algorithmically? it sounds like something I should be doing