When we tested single factors, the portfolio sizes were quite large. As our back test universe was quite large, with an average of 1500 companies, the average portfolio’s size per quintile was around 300 companies. It is not practical to have a portfolio with such a large number of companies. Thus in the two-factor strategies we tested, we formed portfolios with 30 to a maximum of 60 companies for each quintile. We did this by taking the first quintile of the first factor we tested (about 300 companies), sorting it by the second factor, and dividing it into five quintile portfolios (300/5=60). By testing the two factors this way, you have the added advantage of accurately identifying the stronger and weaker factor, as the first factor is emphasized due to the inclusion of only its first quintile companies.

For the two-factor tests, we did not split the universe into different market capitalizations as in doing so, we would not have been able to form portfolios with at least 30 to 60 companies.