Predicting size and value returns. Can short-term value and size premiums be predicted?

The economic and societal goal of asset management is to allocate assets most efficiently, which implies: providing capital to entities that are able to use it as a resource to create highest economic value added, while managing the volatility of these returns. A widely used way to do this is via factor investing: allocation based upon other measures than price (or market capitalization); often fundamentals. Factor investing provides an opportunity to reap more return, without increasing the volatility of a portfolio. In order to capture value and size returns efficiently, timing is important and to that extent, predictors of factor returns are valuable. This thesis describes possible predictors of these returns; provides their economic rationales; tests whether they do predict factor returns; and concludes with recommendations to asset managers. This research project can be seen as a scientific empirical test of indicators that Kempen Capital Management (KCM) already uses to invest in the value and size factor. Furthermore, it is an attempt to increase the predictability of the value and size returns using macro economic, market, and behavioral factors KCM did not use yet. Figure 1 shows the framework of this thesis with the paths used to translate observations in the domains of macro economy, the financial market, and investor behavior to predicting the returns of SMB and HML portfolios.