Articles & Interviews

Articles & Interviews

11 December 2023

The Expected Size Premium Has Never Been Higher

In the collective consciousness, there is a prevailing awareness that the trajectory of the US stock market this year has predominantly hinged on what is commonly referred to as the 'Magnificent Seven.' Investors are expressing a noteworthy concern, particularly regarding Index Concentration. Beyond the evident implication that stock market concentration signifies a lack of diversification in the idiosyncratic risk associated with large-cap names in the market portfolio, this month's research delves into the quantitative expression of this phenomenon on the Size Premium.*

The study1 commences by employing the Herfindahl-Hirschmann index to gauge the degree of concentration in the market precisely. It establishes that the concentration in the US stock market has reached levels last witnessed in 1970, marking a one-standard deviation reversal to the sample mean from the tail levels of 1995. It subsequently reveals that the Herfindahl-Hirschmann index is a positive predictor of the size premium, concluding that it rises in tandem with market concentration. To elaborate, a one-standard-deviation shift in stock market concentration results in a 9.54% annual increase in the expected size premium. Consequently, it is currently at its peak in the US, mirroring the situation in other highly concentrated markets such as Emerging ones.

Keeping an eye on the current market concentration is crucial when crafting a vibrant and well-diversified portfolio that spans regions and market capitalisation segments. It serves as a key factor in deciphering the potential premiums that can be reaped in the future.

*The Size Premium is defined as the tendency of relatively low market capitalisation to earn superior returns than firms with relatively high market capitalisation.

1Emery, L. P., & Koëter, J. (2023). The size premium in a granular economy. Social Science Research Network.

Benoit Lahaye
Junior Investment Analyst



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