The Barron’s 400 Index followed its stellar 2013 results with an respectable total return of 7.1% in 2014, which, nevertheless, failed to keep pace with the overall market. The Dow Jones U.S. Total Stock Market Index, B400’s bogey, gained 12.5% for the year, including dividends, as investors favored large and mega caps over small and mid cap companies (even though B400 has 72 constituents with a market cap of more than $20 billion, its equal-weighting scheme puts it at a disadvantage to market cap-weighted benchmarks during an environment that favors large caps). B400 nevertheless maintains a cumulative advantage of 991 basis points (9.9 percentage points) over the benchmark in the five-year period ended on New Year’s Eve. A close examination of the market’s dynamics in 2014, from B400’s perspective, is useful as we start 2015 in the context of what clearly appears to be an accelerating U.S. economy (more on what this means for B400 later).
Over or under performance, across any period of time, can be attributed to an active exposure, relative to the overall market, to a particular style, size or sector(s). A periodic evaluation of such exposures and their contribution to the index’s performance, in the case of B400, is a useful illustration of how its bottom-up security selection drives its results. In the case of the year just ended, it clarifies where its underperformance relative to the overall stock market came from.
From a style and size perspective, B400 maintained through last year its traditional mid cap growth tilt (the market’s ‘sweet spot,’ as we like to call it), which has characterized it since it was first introduced more than seven years ago on the cover of Barron’s. A breakdown of its returns relative to the Dow Jones U.S. Total Stock Market Index unsurprisingly shows a significant underweight to large caps, across both growth and value and a significant overweight to mid and small caps. The table and chart appearing below illustrate the actual tilts based on the Russell 6 Style Indices1 last year.
| Russell Style | Barron’s 400 | DJ US TSM | Difference | By Mark. Cap |
| Large Cap Growth | – | 31% | -31% | -62% |
| Large Cap Value | 1% | 32% | -31% | |
| Mid Cap Growth | 47% | 15% | +32% | +25% |
| Mid Cap Value | 7% | 14% | -7% | |
| Small Cap Growth | 13% | 4% | +9% | +38% |
| Small Cap Value | 32% | 3% | +29% |
The next chart provides a nice illustration of where the overall portfolio (B400) falls within the Russell Style Indices relative to DJUSTSM based on its performance in 2014. Unsurprisingly, its growth tilt, while still pretty dominant, faded a little in favor of value as many of its small cap names corrected significantly.
While this style analysis begins to paint a picture of how differences in B400 style tilts may have contributed to an underperforming year, it only tells a partial story. More specifically, isolating performance attribution only by market size goes further toward explaining last year’s results, which is what we did next. Considering the strong performance turned in last year by U.S. large cap equities in general, the performance attribution analysis of B400, used for the next part of our analysis, was run against a different broad market index, the Dow Jones U.S. Index (DJUST), which, while comprised of approximately 1,200 constituents and covering over 95% of the domestic stock market, holds mostly mid cap and large cap names. This index gained 12.9%, on a total return basis for the year, 580 basis points ahead of B400. The table below illustrates the exposure of B400 last year to all market cap segments, broken down by deciles (largest 10%, followed by second largest 10% and so on) and how this compares to DJUST. The attribution itself, on the far right of the table, shows where B400 struggled. Any positive number in the attribution effect column represents a positive contribution by the stocks in a given decile to the performance of B400 relative to the benchmark. Any negative number, on the other hand, represents the basis points by which the stocks in that particular decile trailed the equivalent group in the benchmark.
| Market Cap | B400 | DJUST | Diff. | Lrg/Mid/Sml | Attribution Effect |
| Decile 1 | 12% | 57% | -45% | -52% | 0.35 |
| Decile 2 | 8% | 15% | -7% | -0.10 | |
| Decile 3 | 9% | 9% | – | -0.23 | |
| Decile 4 | 7% | 5% | +2% | +16% | -0.08 |
| Decile 5 | 8% | 4% | +4% | 0.06 | |
| Decile 6 | 8% | 3% | +5% | 0.02 | |
| Decile 7 | 7% | 2% | +5% | -0.77 | |
| Decile 8 | 6% | 2% | +4% | +38% | -0.41 |
| Decile 9 | 7% | 1% | +6% | -0.84 | |
| Decile 10 | 29% | 1% | +28% | -4.17 |
The table clearly shows that despite having a much smaller representation among large caps (top three deciles), B400 hardly trailed the benchmark in that segment. In fact, it only did so by a total of 20 basis points despite an incredible 52% underweight. In other words, B400’s large caps more than held their own during the year just ended.
What really made a difference last year in terms of performance is clear from the last three deciles, among which B400 underperformed the benchmark by 542 basis points in large part because of an overexposure to this market cap segment of 38%. In fact, the companies in the three smallest cap deciles (keep in mind that B400’s minimum market cap is a float-adjusted $250 million, so it isn’t really exposed to micro-caps), which accounted for 42% of the index’s weight last year, accounted for 88% of the index’s underperformance relative to the broad market benchmark. This is not only remarkable but also illustrates very clearly why equal-weighted schemes, or active management for that matter, struggle to keep up with a rally heavily tilted in favor of large caps. In B400’s case, we have always argued that it is not the small/mid cap tilt that is the source of its strong long-term historical performance, but rather its focus on growth-at-a-reasonable-price (GARP) through its bottom-up stock selection process. This is why although the index may underperform the market at times, in the long run it captures the growth inherent in equities and then some, as it focuses on the best names in the market.
Lastly, to further support our argument that B400’s performance last year suffered from the market’s large-cap bias rather than style or sector tilts, we present below the results of our sector attribution analysis, which allows us to see how much the index under or over performed the benchmark on a sector-by-sector basis. The table below illustrates B400’s breakdown by economic sector relative to DJUST last year2.
| Economic Sector | B400 | DJUST | Diff. | Attribution Analysis | ||
| Allocation Effect | Selection Effect | Total Effect | ||||
| Consumer Disc. | 20% | 13% | +7% | -0.24 | -0.70 | -0.94 |
| Consumer Staples | 6% | 9% | -3% | -0.05 | -0.41 | -0.46 |
| Energy | 7% | 9% | -2% | 0.21 | -2.07 | -1.87 |
| Financials | 15% | 17% | -2% | 0.06 | -1.09 | -1.04 |
| Health Care | 8% | 13% | -5% | -0.54 | 0.36 | -0.18 |
| Industrials | 16% | 11% | +5% | -0.23 | -0.09 | -0.32 |
| Information Tech. | 17% | 18% | -1% | -0.10 | -1.15 | -1.25 |
| Materials | 5% | 4% | +1% | -0.00 | -0.05 | -0.05 |
| Telecommunications | 0% | 2% | -2% | 0.14 | 0.13 | 0.27 |
| Utilities | 0% | 3% | -3% | -0.37 | -0.02 | -0.40 |
Unlike in the market cap attribution analysis presented above, where a single segment accounted for the lion share’s of B400’s underperformance to the benchmark, there isn’t a single economic sector that stands out as being largely responsible for any significant over or under performance. Here an explanation of the attribution analysis illustrated in the table above is warranted: the ‘Allocation Effect’ column refers to how much of B400’s under or over performance for any given sector is owed to its exposure to that sector relative to the benchmark. The ‘Selection Effect’ column refers to the actual security selection within that sector, also relative to the benchmark. ‘Total Effect’ refers to the combination of the two.
From this analysis it is clear that hardly any performance difference came from being over or under exposed to any particular sector (Allocation Effect). In fact, the biggest positive effect for B400 came from being slightly underexposed to Energy, where a 2% underweight amounted to 21 basis points in positive outperformance. The biggest negative effect on B400’s sector allocation came from its 5% underweight to Health Care, resulting in 54 basis points in underperformance. This is not surprising considering health cares stocks just turned in another very strong year.
The bigger divergences between B400 and DJUST, on a sector basis, came from the selection effect within each sector, as illustrated by the ‘Selection Effect’ value. Ironically, the biggest negative effect came from the index’s selections in the Energy sector, which accounted for 187 basis points in underperformance. This shows how, even though B400 had a net underweight to the sector, by picking smaller cap energy names, it underperformed the benchmark, which, by definition, is more exposed to the mega cap names in the sector. Nevertheless, it is clear from the ‘Total Effect’ column that no single sector was largely responsible from the index’s performance relative to the benchmark. This offers further proof that it was its exposure to small caps, which performed poorly last year, which largely accounted for B400 trailing the benchmark.
With 2014 in the rearview mirror, a look ahead, again from the perspective of B400, should naturally follow the analysis above. That will be the subject of our next Newsletter lest we overextend ourselves (any further!) this week. In the meantime, our best wishes to all our readers for a healthy and prosperous New Year!
[1] Source: FactSet. [2] Sector classification according to GICS (Global Industry Classification Standard). Source: FactSet
