After my last post updating quant system performance I realized I’ve never posted on one of the quant systems, the microcap trending value system. In this post I’ll describe the microcap trending value system, its historical performance, and a tweak from the O’Shaughnessy version of the system which improves performance.
The top performing quant system, by annual return, from O’Shaughnessy’s What Works On Wall Street is the microcap trending value system. From the Table 28.1, page 597, from 1965 through 2009 the strategy returned 22.33% per year with a standard deviation of 20.38%, Sharpe ratio of 0.85, and a max drawdown of -53.89%. Below is a snapshot of the top 10 performing strategies by annual return. 5 of the top 10 strategies are microcap strategies.
The top strategy, which I call the microcap trending value strategy, takes the top 30% of microcap value stocks ranked by P/B, then sorts that list by 52 week momentum. Microcap is defined as $50M to $200M in market cap. It further narrows that list by requiring that the stocks had positive returns over the last 3 and 6 months. The strategy then buys the top 25 by equal weight. Hold for one year. Rinse and repeat. Pretty simple once you’ve implemented a few of the other quant strategies. The strategy is easily implemented in P123. Lets see how the strategy performs in P123 from 1999 through yesterday. Below are the results.
I’ve compared the strategy to the small cap index. P123 does not have a valid microcap index that goes that far back. As you can see the microcap strategy underperforms the small cap index by about 2% a year. More interestingly, the strategy outperforms until the financial crisis then starts to underperform. So, something changed. And it has to do with P/B as a value metric.
What I found confusing is that O’Shaughnessy spends a great deal of the book talking about how a composite of value factors is far superior to a single value factor but never applies the composite value factor to microcaps. Lets do that. Below are the results of a microcap trending value screen, as above, with the only difference is that we use the VC2 composite value factor to filter for value stocks.
Much better. The composite value factor is far more effective, not only since the financial crisis but pre crisis as well. Since 1999 the strategy has returned 23.2% per year with a drawdown of 41%.
I summary, the microcap trending value strategy is a great performing strategy with great absolute and risk adjusted performance. When I talk about the microcap quant strategy on the blog, I’m referring to this version of the microcap trending value strategy.
Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.