With MiFID II approaching this January, market liquidity is a concern, a report from Morgan Stanley notes. So how does liquidity impact factor investing? Brian Hayes and his quantitative research team at the investment bank broke down how liquidity factors impacted stock price performance, discovering some regional and factor category differentials that provides a roadmap to enhanced entry and exit points. But it also revealed that under certain circumstances liquidity does not play a part in rising or falling factor performance.

Factor investing: Liquidity does not impact the US to the same degree as it does other global regions

Considering market capitalization and quantitative factors in a stock category – based on market cap, but also growth, value, momentum, for instance – the study yielded mixed results. In certain sectors, liquidity did not play a major role in price direction but in other areas it did.

When considering market capitalization in the US, stock market volume, used as a proxy for liquidity, “average returns were not significantly different in low vs non-low days,” the report stated. “.For the US, average cohort performance does not appear to be different in low liquidity periods.”

The US, however, is different than other regions where factor performance models show a more pronounced returns profile based on liquidity.

In Europe, Canada and Latin America, there was a different pattern of performance based on market capitalization. In general, large cap stocks underperformed on low volume days while small cap stocks outperformed, sometimes significantly. Mid-cap stocks, meanwhile, showed no discernible pattern relative to low or high volume days.

One generalization that held true was that across all regions and market capitalization categories was that low volatility exhibited a significantly high correlation with low volume. Morgan Stanley explains:

Low volume days may lack catalysts that could drive cheap stocks to rebound (or expensive stocks to sell off): we have observed that market volatility is lower in low volume days, and this may be a reflection of the lack of events/data on these days. Alternatively, investors may not be interested in taking a risk on value stocks in low volume days, as there is generally viewed to be a risk premium associated with value stocks.