Market Map Model 2 : Using Small Cap Value Weighted Portfolio

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 |  Includes: QQQ, TLT
by: Market Map

This article examines Market Map model 2 applied to a portfolio with a tilt towards a small capitalization "value weighted" methodology. The portfolio constructed using this methodology is based on the Fama/French "factor" model; the factors being beta, size, value, and momentum. The DFA US Small Cap Value (MUTF:DFSVX), a mutual fund whose composition utilizes the factor model, was created through the efforts of Dimensional Fund Advisors dfaus.com.

Additionally, the analysis combines MMap model 2 with a "Sell in May" component, both of which are applied to the Small cap data. The initial details of Market Map model (as applied to the S&P500 index) are covered here and the "Sell in May" primer is here.

Table 1

Market Map model 2 + Sell in May allocation dates using Small cap indices data and 30 yr. Bond proxy 86 years (1927-2013)

Small Cap Value ( SV )
with Market Map model 2 return per
and Sell in May period
BOND = 75% allocation
01/18/1927 SV 7.3%
04/31/1927 cash 1.0%
10/31/1927 SV 22.5%
04/31/1928 cash 1.0%
10/31/1928 SV 15.7%
06/31/1929 cash 0.5%
10/31/1929 SV -3.4%
04/31/1930 cash 1.0%
10/31/1930 SV -3.1%
04/31/1931 cash 2.0%
04/31/1932 SV 806.0%
04/31/1937 cash 2.0%
04/31/1938 SV 10.0%
04/31/1939 cash 2.0%
10/31/1939 SV 4.5%
04/31/1940 cash 2.0%
02/10/1941 SV 539.0%
07/08/1946 BOND -4.7%
10/01/1946 SV 3.3%
12/31/1946 cash 0.0%
04/31/1947 SV 201.7%
04/31/1953 cash 2.0%
10/31/1953 SV 138.2%
04/31/1956 cash 1.0%
10/31/1956 SV 8.8%
04/31/1957 cash 2.0%
04/31/1958 SV 60.1%
04/31/1960 cash 0.5%
07/05/1960 BOND 2.0%
10/31/1960 SV 27.4%
04/31/1962 cash 1.0%
09/31/1962 SV 95.0%
04/31/1965 cash 1.0%
10/31/1965 SV 34.6%
04/31/1966 cash 0.0%
09/31/1966 SV 6.6%
12/31/1966 cash 0.0%
02/02/1967 SV 83.8%
04/31/1968 cash 1.0%
10/31/1968 SV 2.2%
04/31/1969 cash 3.0%
09/31/1970 SV 27.5%
04/31/1973 cash 1.0%
10/31/1973 SV -11.7%
04/31/1974 cash 1.0%
09/31/1974 SV 1.3%
12/31/1974 cash 45.6%
03/01/1975 SV 2.0%
04/31/1977 cash 1.0%
10/31/1977 SV 29.0%
04/31/1978 cash 1.0%
09/31/1978 SV 134.4%
04/31/1981 cash 1.0%
10/31/1981 SV 1.2%
04/31/1982 cash 1.0%
09/03/1982 BOND 4.1%
10/01/1982 SV 60.0%
04/31/1984 cash 1.0%
10/31/1984 SV 100.8%
06/31/1987 cash 2.0%
05/31/1988 SV 33.6%
04/31/1990 cash 1.0%
09/31/1990 SV 77.1%
06/31/1992 cash 3.4%
07/10/1992 SV 2.4%
09/31/1992 195.3%
07/11/1997 BOND 5.0%
10/02/1997 SV 9.7%
04/31/1998 cash 0.5%
07/02/1998 BOND 7.3%
10/02/1998 SV 35.1%
07/09/1999 BOND 1.1%
10/02/1999 SV 47.3%
04/31/2000 cash 0.5%
07/06/2000 BOND 2.6%
09/28/2000 SV -1.1%
04/31/2001 cash 0.5%
07/06/2001 BOND 5.6%
10/31/2001 SV 22.1%
04/31/2002 cash 13.4%
07/05/2002 BOND 11.9%
10/04/2002 SV 6.9%
12/31/2002 cash 0.0%
02/13/2003 SV 126.0%
04/31/2008 cash 0.5%
07/05/2002 BOND 3.4%
09/31/2008 SV 1.0%
03/31/2009 cash 31.8%
07/09/2010 BOND 5.0%
09/31/2010 SV 24.3%
07/08/2011 BOND 16.0%
10/31/2011 SV 68.8%
hold SV data through 10/2013
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Table 2

Statistics for table 1:

Small Value B&H Small value Market Map model 2 Small value Market Map model 2 + Sell in May
86 year 86 year 86 year
CAGR 17.8% 20.7% 22.8%
Average 19.6% 20.8% 22.7%
Standard Deviation 31% 26% 25%
Sharpe Ratio 0.63 0.81 0.92
Cum % during invest (incl Bond % ) 1906% 1937% 2152%
cum % during cash n/a -52% -121.6%
# of trades n/a 95 100
% of months BOND invested n/a 3.4% 3.4%
$1 becomes $1,317,675 $10,515,200 $46,199,342
Max Drawdown 2007-2008 1978 1978
-51.0% -23.2% -23.2%
Worst month -26.8% -23.2% -23.2%
% positive months 64% 68% 69%
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Table 2 shows that over an 86 year period, both the Market Map model 2 and MM model 2 + the "Sell in May" component outperformed the Small Cap value buy an hold with less risk, with the "Sell in May " component outperforming by a wide margin.

Tables 3-6

Historical annual returns tables 25 years:

Small Cap Value
Buy and Hold
Year Annual return $1 becomes
$1.00
1989 27.9% 1.28
1990 -12.6% 1.12
1991 63.9% 1.83
1992 22.1% 2.24
1993 29.0% 2.88
1994 0.7% 2.91
1995 42.8% 4.15
1996 20.4% 5.00
1997 32.1% 6.60
1998 6.2% 7.01
1999 13.30% 7.94
2000 9.00% 8.65
2001 22.30% 10.58
2002 -9.30% 9.60
2003 59.40% 15.30
2004 25.40% 19.19
2005 7.80% 20.68
2006 21.50% 25.13
2007 -10.70% 22.44
2008 -36.80% 14.18
2009 33.60% 18.95
2010 30.90% 24.80
2011 -7.50% 22.94
2012 21.70% 27.92
2013 38.60% $38.70
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Small Cap Value
with Market Map model 2
Year Annual return $1 becomes
$1.00
1989 27.9% 1.28
1990 -2.1% 1.25
1991 63.9% 2.05
1992 3.6% 2.13
1993 29.0% 2.74
1994 0.7% 2.76
1995 42.8% 3.94
1996 20.4% 4.75
1997 19.1% 5.65
1998 26.3% 7.14
1999 14.20% 8.16
2000 3.40% 8.43
2001 7.20% 9.04
2002 20.10% 10.86
2003 62.70% 17.66
2004 25.40% 22.15
2005 7.70% 23.86
2006 21.50% 28.99
2007 -10.70% 25.88
2008 -0.80% 25.68
2009 50.30% 38.59
2010 22.10% 47.12
2011 21.50% 57.25
2012 21.70% 69.68
2013 38.60% $96.57
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Small Cap Value
with Market Map model 2
and Sell in May
Year Annual return $1 becomes
$1.00
1989 27.9% 1.28
1990 3.7% 1.33
1991 63.9% 2.17
1992 21.8% 2.65
1993 29.0% 3.42
1994 0.7% 3.44
1995 42.8% 4.91
1996 20.4% 5.92
1997 14.8% 6.79
1998 45.5% 9.89
1999 27.00% 12.56
2000 9.70% 13.78
2001 7.60% 14.82
2002 20.50% 17.86
2003 59.60% 28.51
2004 9.97% 31.35
2005 22.87% 38.52
2006 21.52% 46.81
2007 -10.75% 41.78
2008 0.30% 41.90
2009 53.30% 64.24
2010 22.30% 78.56
2011 21.90% 95.76
2012 21.76% 116.60
2013 38.60% $161.61
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NDX/QQQ
with Market Map model 2
Year Annual return $1 becomes
$1.00
1989 26.3% 1.26
1990 8.5% 1.37
1991 65.5% 2.27
1992 -6.0% 2.13
1993 10.6% 2.36
1994 1.5% 2.39
1995 42.6% 3.41
1996 42.5% 4.86
1997 24.60% 6.06
1998 45.3% 8.80
1999 31.3% 11.55
2000 7.6% 12.43
2001 5.80% 13.15
2002 31.7% 17.32
2003 51.3% 26.22
2004 10.4% 28.95
2005 1.5% 29.38
2006 6.7% 31.36
2007 18.7% 37.22
2008 -9.2% 33.79
2009 76.8% 59.75
2010 13.6% 67.87
2011 21.7% 82.60
2012 16.8% 96.45
2013 27.2% $122.71
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Table 7

Historical statistics based on tables 2-5 using MM model 2 with Small cap value and Nasdaq 100/QQQ (1989-2013):

Small Value B&H Small value Market Map model 2 Small value Market Map model 2 + Sell in May NDX/QQQ Market Map model 2
return 25year 25year 25year 25year
CAGR 15.7% 20.1% 22.6% 21.2%
Average 16.1% 19.5% 21.9% 20.9%
Standard Deviation 23% 19% 18.5% 18%
Sharpe Ratio 0.71 1.02 1.19 1.13
Cum % during invest (incl Bond % ) 451% 536% 596% 573%
cum % during cash n/a -23% -43.8% -30.8%
# of trades n/a 36 41 36
% of months BOND invested n/a 9.5% 9.5% 9.5%
$1 becomes $39 $97 $162 $123
Max Drawdown 2007-2008 2007-2008 2007-2008 2007-2008
-51.0% -14.4% -16.4% -18.5%
Worst month -26.8% -10.0% -11.0% -11.5%
% positive months 64% 71% 70% 64%
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Table 8

Annualized returns summary 5, 15, 25, 86 years:

Annualized returns
5 Years 15 Years 25 Years 86 Years
a

Small value

Buy & hold

24.0% 12.2% 15.7% 17.8%
b Small value with Market Map model 2 30.3% 19.0% 20.1% 20.7%
c Small value with Market Map model 2 + Sell in May 31.0% 20.5% 22.6% 22.8%
d Nasdaq 100/ QQQ with Market Map model 2 29.4% 19.2% 21.2% n/a
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In viewing tables 3-8, the Market Map model 2 combined with "Sell in May" component (table 8 item c) outperformed items a, b, and d. The "Sell in May" component improved the performance of the series when applied to the Small cap value portfolio, but didn't provide performance improvement when applied to the Nasdaq 100/QQQ index (analysis not shown). The reason for the performance superiority of "Sell in May" when applied to the Small cap universe is unknown; perhaps there is/was performance advantage gained during the November-December period years when the "Sell in May" was invested and the MM model 2 was in cash ?.

As the work of Fama and French has proven that a Small cap 4 factor model is dominant in compound return and risk versus the performance of the other Morningstar style box classifications, an interesting aspect of this study is that the QQQ ETF, while representing a "large cap growth/blend" classification in the style box, has returns comparable to items b and c in table 8 with similar risk characteristics when the Market Map model is applied. In determining the best performing asset vehicle for investment in the Market Map program, one aspect that can give the QQQ ETF an advantage over a Small cap value fund over a long investment time frame, is the consideration of management fee and tax ratios. In terms of Tax Cost and Net Expense Ratios, QQQ has much lower ratios than those of the DFA US Small Cap Value.

We believe that a small cap value factor portfolio has greater return potential than the QQQ as measured by the MMap model results and by the research conducted by Fama and French. Yet, until a low expense and low tax ratio exchange traded fund that reflects an underlying Small Value Momentum factor methodology becomes available and accrues reasonable trading history, we favor the use of the QQQ ETF as the appropriate "small cap" investment vehicle for the Market Map model for the foreseeable future.

"When everyone is looking for the needle in the same haystack, go look in a different haystack"

Sources for Small Cap indices and historical performance data compiled for the analysis and calculation for the tables below are:1) the DFA US Small Cap Value I (1999 to 2013) from Morningstar 2) the "Small capitalization Average Value Weighted" portfolio formed on size and momentum (1927-1998 ) from Kenneth R. French data library 3) the Nasdaq 100 index (1989-1999)/Powershares QQQ Trust ETF (NASDAQ:QQQ) (2000-2013) and 4) Barclays iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT) / Vanguard Long-Term Treasury Fund Investor Shares (MUTF:VUSTX) / or 30 year bond rate.

Disclosure: I am long QQQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.