Asset Allocation: It's All About Style

The most recent academic research indicates that asset allocation can be responsible for as much as 90% of performance attribution. This is the bread and butter of the advisory and consulting business. The key is to optimize portfolios in such a way to maximize performance and minimize risk. In the equity arena there are four main components that explain manager performance: Style (Growth, Value or Core), Market Capitalization, Sector Exposure, and Stock Picking. By closely analyzing these four components manager performance can be broken down into building blocks and it is possible to determine what is really driving returns.

With that as our backdrop, let’s take a look at an interesting development over the last week: The Russell 2000 Value went negative for the year on Friday and is now down 1.2% year-to-date, whereas the Russell 1000 Growth is still up 8.2% year-to-date. This points to a stratification in the equity markets, in general, Growth has outperformed Value this year and the disparity becomes exaggerated as we move down in market capitalization. Note the performance spread in the S&P500 Growth (+3.97%) versus S&P500 Value (+1.83%) is 2.14%, while the performance spread in the S&P600 Growth (+6.18%) versus S&P600 Value (-0.79%) is 6.97%.

Taking the analysis one step further let’s take a look at sector performance this year. The disparity here is shocking. Energy, Materials and Industrials have all performed extremely well this year, all up over 10% regardless of market capitalization, with the best performer being Mid Cap Energy up over 20%. Here’s where it get’s shocking. Financials are not only down for the year, but they are down big. Small Cap Financials are down over 20% for the year. Financials have been the race car leading the economy the last several years, but it would now appear the wheels have come off.

Here’s where it gets even more interesting, we can tie it all together and explain the disparity between Growth and Value. The Russell sector weightings for financials are roughly double for Value compared to Growth. Which means the majority of the overall disparity is related to the underperformance in Financials for the year.