Tag Archives: investing
The Small-Cap Premium Is Still MIA As A Buy & Hold Strategy
Yesterday’s post focused on the discouraging record for value investing over the last decade, but history looks even worse for the so-called small-cap premium in the US stock market. Yes, there have been periods when small cap shines relative to large caps, but the strategy has been a loser as a buy-and-hold proposition since 1980, based on Russell indexes. Excluding the “junk” or focusing on the “value” opportunities in the small-cap realm offers possible solutions, but the original concept using the Russell benchmarks is battered and bruised. Consider the cumulative results of the daily return spread for the Russell 2000 Index (a popular measure of US small caps) less the Russell 1000 (large caps) since the close of 1979. A dollar invested at the start of this period has faded to roughly 70 cents as of yesterday (Apr. 12, 2016). To be fair, there have been multi-year periods during the interim when small caps have outperformed large caps. But over the grand sweep of the last 35 years or so, sans timing, the small-cap concept has been a dog. Click to enlarge There are several explanations for why the small cap premium has been so elusive across the decades, although the most devastating view is that it was all a big head fake. Critics are quick to point out that the disappointing returns for small caps followed the arrival of the famous study by Rolf Banz in 1981 that put the strategy on the map and launched an industry dedicated to mining this premium. But as NYU finance professor Aswath Damodaran recently asked: “The Small Cap Premium: Where is the beef?” Arguably the best case for salvaging the strategy lies with the notion that it’s best to ignore the financially troubled firms. As I discussed last year, a recent study by Cliff Asness of AQR Capital Management and several co-authors – “Size Matters, If You Control Your Junk” – points to a fix by focusing on small companies with relatively strong financials. Nonetheless, small-cap investing as originally conceived comes with a hefty degree of empirical baggage these days. Optimists counter that the general run of disappointing small-cap performance lays the groundwork for hefty opportunities for the years ahead. Meantime, there’s another argument to counter the skeptics: small-cap value is where the real action is, as per the Fama-French research. In a future post, I’ll crunch the numbers and run a reality check on that idea. As for traditional small-cap investing a la Banz, history hasn’t been kind to the original strategy, at least when measured in the Russell indexes as a buy-and-hold setup. That doesn’t mean that the small-cap concept is dead. But some fancy footwork is required to make it work.
Beat Weak Q1 Earnings With Revenue-Weighted ETFs
The overall Q1 earnings picture looks bleak, with projected earnings growth deep in the negative territory for the fourth consecutive quarter. In fact, the magnitude of negative revisions over the last three months has been the highest among the recent quarters. Q1 earnings are expected to decline 11.1% versus the 6.4% drop in Q4, as per the Zacks Earnings Trend . However, the projected revenue decline of 2.3% for Q1 is much better than the Q4 revenue decline of 6.6%. Against this backdrop, revenue-weighted ETFs will likely take the lead over earnings-weighted strategies and could be the potential outperformer this earnings season. Why Revenue-Weighted ETFs? First, while a series of headwinds have been weighing on the profitability of companies, the depreciation in the dollar could offer some relief to the top line. As such, many companies could come up with an unexpected growth in revenues in their quarterly reports, giving a boost to the revenue-weighted ETFs. Notably, the ICE U.S. Dollar index, a measure of the dollar’s strength against a basket of currencies, fell to the lowest level in nearly eight months. Second, revenue-weighted funds have outperformed the earnings counterparts in both the short and long-term periods, proving the credibility of the superior weighting methodology. This is because revenues are a better indicator of a company’s financial health. The top line is harder to manipulate or alter on a quarter-by-quarter basis, as opposed to earnings, which can easily be fattened using accounting tricks, thereby leading to inaccuracy. The earnings-weighted ETFs do not reflect the true picture of the company and raise the risk in the portfolio. As a result, tilting toward the revenue metric is a more sensible choice. For investors seeking to do this, there is a small lineup of U.S.-focused ETFs that accomplish this task. Below, we have highlighted the funds that could be great choices for investors seeking to make money from the weak earnings season, while at the same time focus on one of the most important aspects of stock investing. RevenueShares Large Cap ETF (NYSEARCA: RWL ) This fund provides exposure to the top revenue-generating companies within the large-cap segment of the broad U.S. stock market. It consists of the same securities as the S&P 500 Index. Holding 500 stocks in its basket, the fund is concentrated on the top firm – Wal-Mart (NYSE: WMT ) – at 4.7% of total assets, while other firms hold no more than 2.4% share. However, the product has a diverse exposure to a number of sectors, with consumer staples, consumer discretionary and financial occupying the top three positions. The ETF has amassed $320.7 million in its asset base and charges 49 bps in annual fees. Volume is light, trading in about 33,000 shares a day. The fund is up 0.8% in the year-to-date time frame. RevenueShares Mid Cap ETF (NYSEARCA: RWK ) This ETF tracks the S&P MidCap 400 Index, providing exposure to the 400 top revenue generators. It is widely spread across components, with none holding more than 3.26% share in the basket. From a sector look, consumer discretionary, industrial and consumer staples take the top three spots with double-digit exposure each. The fund charges 54 bps in fees per year, while it trades in average daily volume of nearly 22,000 shares. It has accumulated $187.7 million in AUM and has added 3.7% so far in the year. RevenueShares Small Cap ETF (NYSEARCA: RWJ ) This fund targets the small-cap segment of the U.S. equity market. It follows the S&P SmallCap 600 Index and holds 600 stocks. RWJ provides a nice balance across a number of components, with each holding less than 2% share in the basket. However, it is slightly tilted toward industrials and the consumer discretionary sector at nearly 22% each, while consumer staples and financials round off the top four. The product has managed assets worth $276.6 million and sees a light volume of about 30,000 shares per day. It charges 54 bps in expense ratio and is up 2.1% year to date. RevenueShares Navellier Overall A-100 ETF (NYSEARCA: RWV ) This ETF is unpopular and illiquid in this space, with AUM of just $7 million and average daily volume of under 1,000 shares. It tracks the Navellier Overall A-100 Index and weighs securities by the top line. The product holds a basket of 100 stocks, which are concentrated on the top 10 holdings at 54.43% of assets. ADRs make up for 23.9% share, while consumer discretionary and consumer staples round off the top three in terms of sector allocation. Unlike the other three, RWV is pretty spread across various market caps, though large caps account for the largest share at 65% of the total. It charges 60 bps in fees per year from investors and gained 0.4% in the year-to-date time frame. Bottom Line Based on the historical performance, the strategy to weigh stocks by revenue seems one of the most effective factors for weighting the index holdings. Though revenue-weighted ETFs cost more, these have the potential to generate higher returns than their earnings counterpart. Original Post