2017 Factor Alpha Newsletter
So far in 2017, investors saw how multi-factor exposure to Value — in concentrated portfolios — can be beneficial in the small cap space.1 This 1Q17 Small Cap2 edition of the Factor Alpha Newsletter (see also: All Stocks & Global Large Cap) compares our proprietary multi-factor themes3 to the Russell 2000® Value Index (R2000V).4
We choose factors that are driven by fundamentals and that work over a full market cycle. And because in any given year one factor can do well or poorly — creating noise in the long-term process — it’s important not to use any of these factors and/or themes in isolation. We suggest using various hybrids of several multi-factor themes to build conviction-weighted high Active Share portfolios. Using “small cap value” as an example, to help explain the strategy’s performance5 the charts below get paired up with our Factor Attribution Tool to customize our quarterly market commentaries.
Here are the live-time 1Q17 small cap factor snapshots:6
First, to see what’s happened so far this year in the small cap market, we’ll isolate the difference in performance associated with the R2000V benchmark’s market cap-weighted methodology versus an equal-weighted selection universe in 1Q17:
Size: “Market Cap-Weighted” less “Equal-Weighted”
(Cumulative excess returns, 1/1/17–3/31/17)
Stocks trading at large discounts to current sales, earnings, EBITDA, and Free Cash Flow.
Stocks with impressive and stable recent total returns.
OSAM Financial Strength
Stocks that use debt responsibly, and aren’t overly reliant on outside financing.
OSAM Earnings Growth
Stocks whose profitability is high and trending up.
OSAM Earnings Quality
Stocks with strong cash flows and conservative accounting.
Stocks returning high amounts of cash to shareholders through dividends and buybacks.
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- Example: In the “cheapest” 10% of small stocks, Consumer Discretionary was overweighted in 1Q17 — yet it was one of the quarter’s lowest-performing sectors. This overweight was a large portion of Value’s underperformance in Small Stocks.
- The Small Stocks universe includes all stocks trading on the NYSE, AMEX, and NASDAQ with an historical inflation-adjusted market cap between $200 million and $2 billion.
- We blend factors together to build proprietary multi-factor themes to help reduce the noise of any one factor, but even investment themes experience cyclical periods of underperformance.
- The Russell 2000 Value Index measures the performance of the small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower Price-to-Book ratios and lower forecasted growth values. The index currently only uses a single factor (P/B) to screen, making it less robust of a “value” signal than the name suggests.
- Bookmark osamscv.com for more info on that strategy.
- The multi-factor portfolios (themes) are calculated using a compositing methodology: Monthly portfolios are created with a 12-month holding period, then the 12 monthly portfolios are combined to create the composite portfolio.
- 1/1/17 – 3/31/17
- For example, Value’s top decile is “the cheapest 10% of stocks” within the universe.