Characteristics or covariances?

Recent research has shown that small, market capitalization and high book-to-market (value) stocks earn considerably higher average returns than the corresponding large stocks and low book-to-market (growth) stocks. Although there are risk or factor-based explanations for this return differential, the empirical research reported in this article supports a characteristics model in which expected returns are not linked to common variation in the returns. As the authors discuss, these empirical results have important implications for performance evaluation and portfolio management.