The Case Against Large Cap Value
(A Revision to Style Index Investing)
Ray Schumacher
February, 2009
The Case Against Small Cap Growth (January 2009) referred to the erratic nature of its Actual versus Expected Return curve (See blue line on graph 12) which gave rise to five false and/or unprofitable switch signals. It concluded that by eliminating Small Cap Growth as a possible holding, the long term advantage over holding the S&P 500 could be increased from 5.3 percent to 6.3 percent per year, and the number of switches reduced from 13 to 8 over the 29 year period.
This raised the question as to whether further improvement might be realized by eliminating another of the three remaining styles. Their returns if held separately were:
Style Average Return
Small Cap Value 15.0% per year
Large Cap Value 13.6%
Large Cap Growth 12.6%
If one could hold only one style forever, Small Cap Value obviously would be it. And since Large Cap Growth earned 1% per year less than Large Cap Value, one might assume it (Large Growth) would be the candidate most likely for elimination. This would be wrong, however, in that we should focus on how these two styles perform during periods when Small Cap Value was not favored by investors and either of the large cap styles was favored. After all, if Small Value is not favored it could be that investor's favor has simply shifted from Value to Growth stocks in which case Large Growth should outperform Large Value. On the other hand, if company size rather than value/growth is behind the shift away from Small Value, then either Large Growth or Large Value could be the better performer.
Historical data indicates that it is a Value/Growth preference on the part of investors and that the preferred alternative when Small Value is not favored is Large Growth instead of Large Value. The following covers the 29 years for which monthly data is available and shows the performance of the two Large Cap indexes when Small Cap Value was not preferred by customers:
|
Small Value Not Favored |
Large Cap Growth Performance |
Large Cap Value Performance | ||||
|
Start |
End |
Number of Months |
Total Return |
Per Month |
Total Return |
Per Month |
|
October 84 |
September 87 |
35 |
114.2 % |
3.3 % |
113.2 % |
3.2 % |
|
September 88 |
December 90 |
27 |
40.5 % |
1.5 % |
21.4 % |
.8 % |
|
April 94 |
May 00 |
73 |
334.9 % |
4.6 % |
182.2 % |
2.5 % |
|
December 06 |
December 07 |
12 |
11.7 % |
1.0 % |
1.2 % |
.1 % |
|
Totals |
147 |
501.3 % |
3.4 % * |
318.0 % |
2.2 % * | |
* Time Weighted Averages
Large Cap Growth consistently outperforms Large Cap Value when Small Cap Value is not favored.
Prior to 1979 we have only annual data going back to 1969 (SBBI 2007 Yearbook page 153). Of the 10 years, the first 5 through 1973 had Small Cap Value out of favor and for this period Large Cap Growth outperformed Large Cap Value by 5.1 percent per year (Average 5.8 % versus 0.7 % per year).
It appears safe to conclude that as long as Small Cap Value is in the picture, the only other style that needs to be considered is Large Cap Growth. Indeed, limiting consideration to only these two styles over the 29 years increased the SII advantage over holding the S&P 500 from 6.3 percent to 6.8 percent per year, and lowers the switches from 8 to 7 with the same switch threshold of 16.0, and safety margin of 1.2 against a false signal to switch to Small Value in December, 1997.
As was the case in deciding to drop Small Cap Growth from consideration, SII Appendices 1 through 9 can remain unchanged, and only appendix 10 needs to be limited to Small Value and Large Growth.
It is rewarding to be able to simplify a process and at the same time increase its efficiency.
Ray Schumacher