In Market Turnaround, Does Size Trump Style?

By Murray Coleman

(Editor's note: The following is the final report of a two-part series analyzing performance characteristics of U.S. stock markets by style and size during the current three-month rally. The first installment, “A Different Sort Of Rally,” can be found here.)

A rebounding stock market is rewarding all types of investors. But some are profiting more than others.

The rally has been much more discriminating in terms of market-cap sizes than styles. For example, from March 9 (when the current rally began) through June 1, small-cap value stocks in the Russell 2000 Value Index have outperformed their Russell large-cap value peers by 7.14 percentage points.

Using the same set of Russell benchmarks as a proxy for the broad U.S. market, small-caps also have dominated of late on the growth side. In that matchup, the Russell 2000 Growth Index is leading the large-cap Russell 1000 Growth Index by 11.32 percentage points over the past three months.

As a result, investing in growth stocks has proved more beneficial for portfolios slanted toward smaller-cap names. On the value side, the differences between market-cap sizes were noticeable but not as pronounced.

Small-Caps Surge Ahead

No matter which style is chosen, however, small-caps have charged ahead of large-caps in this up cycle. Taking a blended approach, the Russell 2000 has surged ahead of the much bigger Russell 1000 by 9 percentage points through June 1. By contrast, from 2008 through March 6 (just before the current rebound in stocks), the style-neutral indexes showed large-caps outperforming by slightly more than 1 percentage point.

Index	Rally (%)	YTD (%)	12-Mnth (%)	3-Yr (%)	5-Yr (%)	10-Yr (%)	15-Yr (%)
Russ 1000	39.63	6.88	-31.13	-7.80	-1.03	-0.95	7.05
Russ 2000	48.63	7.23	-27.25	-9.06	-0.41	3.20	8.78
Diff (pts)	9.00	0.35	3.88	1.26	0.62	2.25	1.73

In a head-to-head study of styles within the same cap sizes, value has been the clear winner in this rally. (See part one of this series here.) Likewise, small has soundly beaten large in terms of cap sizes. And size has generated a bigger cushion than style during this up cycle.

But asset allocators tempted to tweak their portfolios toward more small-caps would have to show remarkable timing to capture the entire 9-percentage point advantage.

Take what would’ve happened if someone had invested in an exchange-traded fund such as the iShares Russell 2000 Index (NYSE: IWM). A purchase at the start of 2009 and held through March 6 would’ve lost almost 5 percentage points more than a similar investment in the iShares Russell 1000 Index (NYSE: IWB). Even if IWM would’ve been held through the initial 30 days of the rebound, the ETF’s returns still would’ve trailed IWB’s by more than a half-percentage point.

The longer-term past-performance records shown above indicate that small-caps tend to eventually provide a performance cushion over large-cap stocks. However, the greater risk inherent in small-caps can make that road to improved fortunes somewhat rocky. Consider that in the past three years through June 1, IWB would’ve outperformed IWM by about 1.5 percentage points.

In the first part of this report, a preference for value during the current rally has produced a 7-plus percentage point advantage in large-caps. In small-caps, that gap was narrower. Contrast that performance cushion for large-cap value with a 9-point style-neutral lead for small-caps.

In either case, this market recovery is offering opportunities for investors to capture overstated gains by taking a potentially more-volatile approach by overweighting smaller names. But it’s also providing a chance for long-term-oriented investors to court less volatility by keeping their large-to-small allocations in place. By tweaking among styles, particularly in large-caps, the ongoing rally appears to provide a possibly improved risk-adjusted means to capture more of the broad market’s upside.

Focusing On Style

Earlier in this series, small-cap value and growth performances were contrasted using respective Russell indexes. Below is a chart breaking down each of the large-cap style indexes by sectors. The period studied is March 9 through June 1. The listed weightings are from the end of that time frame.

Russell 1000 Value	Weight (%)	Gain (%)	Russell 1000 Growth	Weight (%)	Gain (%)
Financial Services	23.73	87.73	Technology	28.34	43.02
Energy	16.60	27.46	Producer Durables	13.01	47.88
Health Care	13.17	23.96	Health Care	13.45	15.96
Utilities	12.74	20.27	Consumer Discry	13.56	39.49
Consumer Discry	9.67	58.47	Consumer Staples	10.40	24.32
Consumer Staples	8.84	24.65	Energy	9.25	47.67
Producer Durables	8.23	63.86	Financial Services	5.46	68.89
Materials	3.83	89.22	Materials	4.33	40.09
Technology	3.19	57.42	Utilities	2.20	41.41

In the large-cap arena, four sectors — financials, energy, health care and utilities — currently comprise more than two-thirds of the value benchmark. While financials are firmly entrenched right now at the top, the growth side’s equivalent giant is technology, at slightly more than 28% of the index. It’s joined by producer durables, health care, consumer discretionary and consumer staples as providing double-digit exposure to the Russell 1000 Growth Index.

Let’s look a little deeper at some of the key drivers of sector performances in this rally for each style.

Russell 1000 Growth Index

• Technology, which leads the second-biggest industry by better than a 2-1 margin, had each of its three main subsectors — telecom, electronics and information tech — produce fairly even returns in the rally. Those ran from around 42% to 45%.

• At No. 2, producer durables is dominated by manufacturers (more than half of the sector’s total) and transporters (another quarter). The former has run up about 44%, and transportation-related constituents increased by some 50%.

• Heath care services was dragged down by its biggest subsectors, pharmas (up 9.7%) and biotech (3.9%). Together, those names held in the Russell 1000 Growth Index generated a combined gain of around 8%. The Russell 2000 Growth’s health care sector has also been bolstered by smaller exposures to medical equipment and services (up 28%) and managed services (up 52%) in the period.

• In consumer discretionary, retail jumped 29%. That subsector comprised almost half of the index’s consumer discretionary category. The other two big pieces, which, combined, almost held the same weighting as retail, were media (up 54%) and leisure (up 42.5%).

Russell 1000 Value Index

• About two-thirds of financial services’ weighting comes from two subsectors – banks and investment banks/brokers. Both made more than 100% gains in the rally. That makes sense considering how beaten down those segments were heading into early March, and explains much of value's recent outperformance compared to growth. Smaller subsectors such as insurance (up 60%) and consumer finance/credit (up 75%) also did well.
  
  Financial services was also a leading sector gainer, barely being nudged out for the top spot by the materials sector.

• The Russell Growth benchmark’s energy category is nearly equally split between equipment/services and nonrenewable energy — basically everything else. However, in the Russell 1000 Value Index, equipment and services are barely represented. That’s good news for value investors. Although energy equipment and service providers have done well, jumping some 81%, others have done even better. Those include offshore oil drillers (154%), gas pipeline services (84%) and oil well services (87%).

• Health care has almost an identical weighting in the large-cap value benchmark as its large-cap growth counterpart. But the former’s returns in health care of late have been far superior. The two indexes are similar in their overwhelming dependence on pharmas and biotechs. The most likely explanation for the difference in performance is that the large-cap value index is skewed more heavily toward pharmas than biotechs. In both style benchmarks, the former is trouncing the latter. As a result, drug makers generated total returns of 20.3% in the Russell 1000 Value index versus 9.7% in the growth benchmark. Meanwhile, biotechs made 9.8% on the value side as compared with 3.9% in the Russell 1000 Growth Index.