Performance Of Factor Tilts: January 2019

Summary

• In an ongoing series, I have illustrated for Seeking Alpha readers how five alternative weighting schemes to the traditional large-capitalization weighted index have produced outperformance.
• I hope a display of these returns and a brief discussion about why these factor tilts deviated from the broader market can help readers with their asset allocation decisions.
• Size, value, and their half-cousin, equal-weighing, outperformed in a strong rebound month for equity returns.
• Low volatility and dividend growth posted strong returns, but these defensive strategies underperformed the broad market.
• Hopefully, with this series, we can all get smarter about smart beta and alternative weighting schema.

In a late 2018 interview with Seeking Alpha editors in my 2019 Outlook piece, I suggested that I was becoming more constructive on equities as valuations cheapened late in the year. While I was becoming increasingly bullish, I did not expect this type of rebound this quickly. The S&P 500 (SPY) produced more than an 8% total return, its best monthly return in more than three years.

It was also a very strong month for the factor tilts that I have covered in this series. Below I show the cumulative performance of my "5 Ways to Beat the Market" from the beginning of the year through last Friday.

_{Source: Bloomberg}

As I showed last month, these five strategies have generated long-run outperformance versus the capitalization-weighted index. Owning smaller-cap stocks, stocks screened from the broad index based on value, stocks with lower realized volatility, stocks with long histories of dividend growth, and a simple equal-weighting of the stock market constituents have all generated market-beating gains.

_{Source: Bloomberg}

While the long-run outperformance of these strategies is demonstrable from the chart above, the table below puts the relative performance of these indices into context over trailing periods.

Below I have listed the performance of exchange-traded funds that replicate these factor indices. Given the more recent inception dates of these funds, we do not have the full histories that we have for the underlying indices above, which is why I will show both in this series. These are certainly not the only ways to get exposure to these factors, and increasing competition in the realm of smart beta is likely to push down expense ratios in the industry going forward.

For these five factors and the S&P 500, I have also calculated the standard deviation of monthly returns. In this series, I am using this volatility measure as a risk proxy. While some buy-and-hold investors may counter that they have a long-term view and are not impacted by market volatility, unfortunately, many individual investors all too often can be whipsawed by market swings. Some investors may prefer strategies with less variability of returns like low volatility and dividend growth. We will also track this measure to ensure that these strategies are delivering on their promise of a smoother return profile.

Discussion Of Recent Performance

Low volatility (NYSEARCA:SPLV) and dividend growth (BATS:NOBL) outperformed in 2018 as the broad market index produced its first negative return in a decade. These strategies, while still posting gains in January 2019, lagged the broader market. Size (NYSEARCA:IJR) and Value (NYSEARCA:RPV) strongly outperformed in the rebound. Equal-weight (NYSEARCA:RSP), which can be seen as an alternative weighting scheme that combines size and value, also outperformed. Simply equal-weighting the 500 constituents in the large cap index produced a 2% higher return in January than weighting those constituents by market capitalization. That signals that the rally has increased its breadth.

If you believe that the stock market is likely to continue to advance, small-cap stocks, value stocks, and equal-weighting should continue to post relative gains. A Fed pause may allow the business cycle to extend and forestall an economic downturn. Even with the potential for the cycle to elongate further, we are still likely late in the business cycle. Monetary stimulus in the form of extraordinary monetary accommodation and ultra-low rates has peaked. Fiscal stimulus in the form of tax cuts and growing budget deficits has likely peaked. Over the next few quarters, size, value, and equal-weighting may outperform; over the next few years, low volatility and dividend growth are likely to outperform. Over decades, I believe there are structural drivers that will make all of these strategies outperform. Readers should position in these tilts based on their respective horizons.

Disclaimer

My articles may contain statements and projections that are forward-looking in nature and therefore, inherently subject to numerous risks, uncertainties, and assumptions. While my articles focus on generating long-term, risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.

Analyst’s Disclosure: I am/we are long IJR, RPV, SPLV, NOBL, RSP, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.