Tag Archives: portfolio

Acceleration In The Underperformance Of Dividend And Value Stocks

The top 20% of SPY components in Dividend and Value have lagged the benchmark for 18 months. The last few weeks have been especially harmful for them. Momentum stocks have widely outperformed. This article compares the trends of four investing styles: Value, dividend, quality and momentum. It doesn’t suggest that investors should use these simplistic models, but it shows how stocks may be influenced by cycles, not only in asset classes and sectors but also in dominant investing styles. Large groups of S&P 500 stocks selected on value, dividend and quality factors have been lagging SPY since the third quarter of 2014. This phenomenon is not limited to small groups. It can be observed in the 100 best stocks of the index in each category. These categories are defined by taking the top 20% of the S&P 500 ranked on a unique factor. The top 20% of value stocks is defined as the 100 S&P 500 stocks with the lowest price/earnings ratio (P/E). The top 20% of dividend stocks is defined as the 100 S&P 500 stocks with the highest yield. The top 20% of quality stocks is defined as the 100 S&P 500 stocks with the highest return on equity (ROE). The top 20% of momentum stocks is defined as the 100 S&P 500 stocks with the highest price increase in one year. Variations in the relative performance of such large groups of stocks on long periods are the expression of behavioral changes in the market. My aim here is to observe and quantify these changes, not to explain them. The next charts show equity curves and statistics of the four “top 20%” groups for one month. The groups are updated and equal-weighted on market opening of the first trading day every week. Dividends are reinvested. Top 20% Value: (click to enlarge) Top 20% Dividend: (click to enlarge) Top 20% Quality: (click to enlarge) Top 20% Momentum (click to enlarge) The next table gives the annualized excess return over SPY of the top 20% group for each category since 1/1/2000, then on the last 12, 6, 3 and 1 months. Annualized excess return of the top 20% stocks in… Since 2000 Last 12 months Last 6 months Last 3 months Last month Value 6.60% -7.45% -16.30% -15.30% -27.76% Dividend 4.61% -7.31% -8.93% -9.55% -32.9% Quality 3.14% -4.29% -6.31% -12.94% -5.82% Momentum 1.12% 2.82% 5.24% -7.06% 8.49% Value stocks have outperformed for 16 years but they have lagged the benchmark since June 2014. The meltdown in energy companies is an incomplete explanation: It’s accountable for less than half of the negative excess return of value stocks. The relative loss of value stocks has accelerated in the last month. Dividend stocks also have lagged for at least one year. Their underperformance has accelerated considerably in the last month. It seems that expectations of a rate hike this week have made some dividend investors more nervous. Momentum stocks have outperformed their own historical excess return for at least one year. They started to lag in the last few months, but their excess return surged again in the last weeks. The transfer of excess return from value and dividend to momentum started more than one year ago and seems to continue. I have written in a previous article that such a pattern is not a reliable clue of a market top . Value and dividend offer a statistical bias on the long term, but in the short term investors following strategies based on these investing styles may experience more frustration before getting back their edge. Indeed, momentum stocks traditionally benefit from “window dressing” at the end of the year: some fund managers buy them to make their portfolios look better in annual reports. If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article. Data: portfolio123

Has Risk Parity Jumped The Shark? Asness Says No

By DailyAlts Staff According to AQR’s Cliff Asness, anyone who thinks risk parity caused the massive selloff in August has gone “all tinfoil-hat”. A better argument against risk parity, Mr. Asness concedes, is the fact that it has underperformed over the past several years. But is this underperformance a result of the strategy having jumped the proverbial shark ? Or is it simply a bad run to be expected with any strategy? Not surprisingly, Mr. Asness thinks it’s probably the latter, and this is the view he articulates in ” Putting Parity Performance into Perspective ,” the alliterative latest in his Cliff’s Perspectives series of white papers. Risk Parity Basics Mr. Asness takes the first few paragraphs of the paper to refresh readers on the basics of risk parity : “an alternative long-term strategic asset allocation” used to “diversify a more traditional equity-dominated allocation.” Rather than weighting holdings by market cap, risk parity weights them based on their anticipated contribution to overall portfolio risk – and in order to achieve the right mix, this means leverage is used to ramp up low-risk fixed-income holdings. From Cliff’s perspective, risk parity offers a “real but modest long-term edge” over traditional approaches because many investors are “too averse” to applying leverage. Risk parity is often described as an “all-weather” solution, succeeding regardless of the broad market’s ups and downs, and Mr. Asness believes this is true – on average . Unfortunately, we’re not living in “average” times, and as a result, risk parity has underperformed since 2009. Longer-Term Returns It’s impossible to do true risk parity back-testing as far back as 1947, so AQR uses “Simple Risk Parity” for historical analysis. The firm’s findings indicate that the “real but modest long-term edge” that risk parity enjoys over indexing really adds up over time. This is evident in the image below, which charts the cumulative excess return of Simple Risk Parity over the past 68 years: The image above shows Simple Risk Parity’s excess returns above cash. The image below shows its excess return above a “60/40” stock/bond portfolio. This helps put the strategy’s underperformance since 2009 into longer-term historical perspective: Forward Outlook Risk parity is designed to diversify away from equity risk. Instead of adding equities to a portfolio in pursuit of desired returns, risk-parity strategies favor using leverage to ramp up fixed-income risk. With equities outperforming for the past six years, it should be no surprise that risk parity has underperformed. Moreover, risk-parity strategies have also been slammed by the bear market in commodities, whereas “60/40” portfolios don’t even have direct exposure to that asset class. But do these facts mean that risk parity’s happy days are over? Not in Cliff Asness’s view. He suggests that the recent underperformance is of the sort that’s to be expected with long-term strategies, and adds that periods of underperformance are often followed by periods of outperformance. The problem, as he sees it, is that short-term periods of poor performance can feel awfully long – and this can lead to investors bailing at the wrong time. If traders have tactical reasons for wanting to allocate away from risk parity, that’s one thing – but selling because of painful results that should be expected from time to time is unwise, in Asness’s view, even if resisting the urge to do so is “one of the hardest but most important parts” of an investment professional’s job.

Does The Size Premium Apply To Countries?

Summary A size premium has been extensively documented in financial literature and some studies have reported a size premium at the country level as well. Portfolios constructed under max-country weight strategies have achieved higher returns and better risk-adjusted performance as measured by Sharpe ratios, albeit with higher volatilities, compared to the benchmark. Max-country weight strategy suggests a potential robust portfolio construction methodology that could provide diversification benefits and improve the portfolio’s risk-adjusted performance compared to the benchmark. Since 1981, the “size premium,” or the tendency for smaller-capitalization securities to outperform their larger-cap counterparts, has been extensively documented in financial literature in the United States. Some studies have extended this research and reported that the size effect applies for country indices as well. Gerstein Fisher conducted research on the relationship between aggregate country equity market capitalizations and country-level market index returns and explored how a market-cap weighted international portfolio can be improved by limiting the weight of larger countries, such as Japan and the United Kingdom, and redistributing weights to smaller countries. For our study, we examined a capitalization-weighted basket of developed-market country indices (excluding the US) that resembles the MSCI EAFE Index. We used this index as our benchmark, and have reported country component weights of this index in the right-most column of Exhibit 1. We then limited the maximum weight of any one country in the portfolio (ranging from a 10% cap to 15%) and re-distributed that weight to all other countries according to their market capitalizations. If, after the re-allocation, any country exceeded the maximum portfolio weight, we repeated the process and re-allocated the additional weights. Exhibit 1, which provides the average exposures of each country in the various country-capped portfolios, and the benchmark over the sample period from January 1997 to July 2015 shows that this process generally reduced the weight of the two largest countries, Japan and the United Kingdom, and added the most weight to the larger of the smaller countries – France, Germany, Switzerland and Australia – resulting in a more even distribution of country weights in the modified portfolio. (click to enlarge) Exhibit 2 reports the performance of our strategy on a cumulative and annualized basis relative to the benchmark; Exhibit 3 shows results on a cumulative basis over time. As shown in both of these exhibits, all of the capped approaches have achieved modestly better cumulative and annualized returns compared to the benchmark over the period from January 1997 to July 2015. Note that this outperformance is achieved with higher volatilities (as measured by annualized standard deviations). The highest volatility (18.45%) is observed for the portfolio applying a 10% country-weight limit and the lowest (17.92%) for the portfolio applying a 15% country-weight limit, compared to 17.14% for the benchmark. Despite the higher volatilities, all capped approaches delivered better risk-adjusted performance as measured by Sharpe ratios (ranging from 0.345 to 0.373), compared to the Sharpe ratio of the benchmark (0.304). (click to enlarge) (click to enlarge) Without further research, we can only speculate about what causes the “small country effect.” The higher return may be explained by the tilts towards the value factor: we have assigned greater-than-market weights to stocks with high fundamentals relative to price and less-than-market weights to stocks with low fundamentals relative to price at the country level in the form of country max limits since smaller countries tend to have higher growth potential and less expensive equity markets. For example, Japan, a country with a relatively low dividend yield, sees its weight in the country-capped portfolios decrease by a range of 9% to 14% with respect to the benchmark. There is a trade-off associated with tilting toward small countries, however, by using this technique. The increased volatilities indicate that small markets are riskier than larger ones. But the increase in volatility is limited since by applying a max-country weight strategy we limit the portfolio’s exposure to any single country, thus enhancing portfolio diversification and lowering concentration risk. Overall, a max-country weight strategy suggests a potential robust portfolio construction methodology that could improve the portfolio’s risk-adjusted performance, as shown by increased Sharpe ratios compared to the benchmark. For more detail and the full results of our study, we invite you to read our research paper, Country Size Premiums and Global Equity Portfolio Structure . Conclusion Our research points to a possible methodology to better structure a multi-country portfolio: varying allocations to different countries based on their equity market capitalizations. As we show, re-distributing some of the weight of larger countries to smaller countries can improve an international stock portfolio’s risk-adjusted performance.