Death (and Rebirth?) of the Size Factor in the USA

Around 2018, however, the size factor in the USA began to show signs of weakness. Then the covid-crisis in 2020 only accelerated its weakening. Some might purport this apparent «death» to the rise of passive index-based investing in which investors tend to invest in market-cap weighted indexes (implicitly biasing inflows towards the large capitalisation stocks). Others note a lack of global competition among the US MegaTech companies, which allows them to grow unrestrained and forming essential monopolies in their individual areas of expertise. Around 2021, the group now known as the «Magnificent Seven» (a term later coined by Bank of America in 2023) arose. These kings of the MSCI USA universe in order of market capitalisation were Apple, Microsoft, Amazon, Alphabet, Meta, Tesla and Nvidia. These Magnificent Seven collectively returned a whopping ~1450% return over the last 8 years, fueling a massive concentration in not only the US equity markets but also specifically in the US Information Technology and Communication Services sectors. Notably, these «Magnificient Seven» alone comprised 23% of the MSCI Developed Markets Index (an index widely used by passive index-based investment funds) at the end of 2024. Naturally, in the MSCI USA universe the concentration of these seven stocks was even higher at 32%.

In factor portfolio analysis, a factor score is typically calculated over the cross-section of an equity index and the underlying stocks are split into equally-weighted buckets (quintiles/quantiles/terciles depending on how many buckets are used), known as sorting portfolios. These buckets are then rebalanced according to a schedule (typically quarterly). In our analysis, our sorting variable is the market capitalisation of the individual stock. We calculate the sorting portfolios using quintiles (20% buckets) but first separate the top 7 stocks in the MSCI USA universe into a separate bucket called «Mega Size». This allows the comparison of the performance of largest 7 stocks versus the other size buckets. Note that the top 7 stocks are not always the «Magnificent Seven» listed above, we simply choose the largest seven by market capitalisation.

In «Figure 1» between mid 2002 and 2018 the classic monotonicity of the size factor buckets can be seen, meaning that smaller size clearly increases the performance of the bucket. Around 2018, however, the size effect completely flipped and now the lower size buckets perform montonically worse than the larger size buckets.

While the size factor may seem to have died, these past 7 years may instead be an anomaly and a rebirth of a size factor is likely. Indeed, recently towards the end of 2024 and beginning of 2025, a rotation has already begun out of largest US stocks (especially the IT/Communication Services sectors) and into smaller stocks, triggered by a correction among IT/Communication Services stocks. If we are indeed entering a period of rebirth of the size factor, then small-size tilt investment funds, such as the OLZ Equity World Optimized ESG which underweights the largest stocks, may provide outperformance over the currently heavily concentrated market-capitalisation weighted indices. One should definitely not simply assume that a few large companies in the long-term will dominate, which presents challenges for investors in passive index products.

Fama, E., French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1) :3-56.

Banz, R. (1981). The relationship between return and market value of common stocks. Journal of Financial Economics, 9(1) :3-18.