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The Dimensions of Stock Returns: 2002 Update

Earlier research of Fama and French, that found size and book-to-market best explain the variation in stock returns, is updated through 2001.

Dimensions

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Evidence from practising investors and academics alike points to an undeniable conclusion: returns are related to risk. Gain is rarely accomplished without taking a chance, but not all risk-taking is rewarded. Financial economics over the last fifty years has brought us to a powerful understanding of the risks that are generally rewarded and the risks that are not.

Three Equity Factors

Everything we have learned about expected returns in the equity markets can be summarised in three dimensions. The first is that stocks are riskier than bonds and have greater expected long-term returns. Relative performance among stocks is largely driven by the two other dimensions: small/large and value/growth. Many economists believe small cap and value stocks outperform over the long term because the market rationally discounts their prices to reflect underlying risk. The lower prices give investors greater upside as compensation for bearing this risk.

Size and Value Matter

In British pounds. UK Value: January 1994 - Present: Simulated by Dimensional from Bloomberg securities data. 1955 - December 1993: UK Large Value Index Source: Elroy Dimson, Stefan Nagel and Garrett Quigley "Capturing the value premium in the UK", Financial Analysts Journal 2003, 59(6): 35-45. UK Small: January 1994 - Present: Simulated by Dimensional from Bloomberg securities data. July 1981 - December 1993: Simulated by Dimensional from StyleResearch securities data. January 1970-June 1981: Elroy Dimson and Paul Marsh, Hoare Govett Smaller Companies Index 2009, ABN-AMRO / Royal Bank of Scotland, January 2009. UK Market is the FTSE All-Share Index, data published with the permission of FTSE. International ex UK Value: January 1994 - Present: Simulated by Dimensional from Bloomberg securities data. January 1975-December 1993: Fama/French International Value Country Indices (ex UK) and Fama/French US Large Value Research Index combined using Market Cap Weights. International ex UK Small: January 1994 - Present: Simulated by Dimensional from Bloomberg securities data. July 1981-December 1993: Dimensional US Small Cap Index plus Dimensional International Small Cap Index less Dimensional UK Small Cap Index combined using StyleResearch Small Portfolio Weights. January 1970-June 1981: 67% Dimensional US Small Cap Index, 33% Dimensional Japan Small Cap Index. Non-UK Market is the MSCI World ex UK Index (net dividends) Emerging markets index data simulated by Fama/French from countries in the IFC Investable Universe. Simulations are free-float weighted both within each country and across all countries. Emerging markets 'market' is the MSCI Emerging Markets Index (gross dividends) MSCI data copyright MSCI 2010, all rights reserved. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Compound returns have an assumed rate of return, are hypothetical, and are not representative of any specific type of investment. Standard deviation is one method of measuring risk and performance and is presented as an approximation.

Two Fixed Interest Factors

Dimensional approaches fixed interest primarily as a strategy to maximise overall portfolio benefit. Shorter-term, high-quality debt instruments tend to have less risk. Dimensional engineers lower-risk bond strategies so investors can temper their total portfolio volatility or take more risk in equities, where expected returns are greater.

Dimensional Fund Advisors Ltd. is authorised and regulated in the United Kingdom by the Financial Services Authority (FRN: 150100). For professional investors and advisers only. You should obtain relevant and specific professional advice before making any investment decision. Past performance is not an indication of future performance. Please read the Important Information.