By Mark Barnes, head of US research and product management
In an earlier blog we looked at the Q1 factor performance of the Russell 1000 Index and its related factor indexes before the US market hit its peak on February 29th and then from the peak to the end of March 31, 2020. In the first period, the R1000 had returned a positive 5.4%, while in the second, it had lost 24.3%. However, we observed that the factor performance in the later period was not simply a reversal of the earlier period. Specifically, Momentum had outperformed, while Value and (small) Size had underperformed during both periods. In this blog, we look more specifically at the Size effect.
The previous blog had looked at the return of the Russell 1000 Size Index. However, to gain more insight into the Size effect, we want to consider the distribution of the Size, or market capitalization, effect and therefore extend it to the Russell 3000 Index. We know that the Russell R1000 had outperformed the R2000 during the first quarter in 2020, but was this effect consistent across the capitalization spectrum?
We took the R3000 constituents and broke them into six equal number capitalization buckets of approximately 500 stocks. If the Size effect were consistent, then we would expect each bucket to outperform buckets with smaller stocks than itself. However, Chart 1 shows that this was not the case. The chart displays the average excess return (excess of the R3000 return) for each of the capitalization buckets, with bucket 1 being the smallest stocks in the R3000 and bucket 6 being largest. The blue bars show the averages for the early period when the index was up, and the yellow bars show the averages in the later period of the sell-off
The blue bars in Chart 1 indicate that the Size effect in the early period was indeed consistent across capitalization, with larger stock buckets (bucket 6) outperforming the small stock buckets. However, the yellow bars from the sell-off period shows a different story.
In the smallest first four buckets (roughly the R2000), the highest average return was in the smallest stock bucket (bucket one) with buckets one and four outperforming buckets two and three. In other words, the Size story was weak in the R2000. However, in the top two buckets (roughly the R1000) the effect seems to be quite strong, with bucket six outperforming bucket five by approximately 6.8%. Finally, we notice that bucket four outperformed bucket five, albeit not by much, indicating that the largest stocks of the R2000 outperformed the smallest stocks of the R1000.
To obtain a more granular view, we undertook the same exercise for the R1000, which we divided into ten buckets of approximately 100 stocks each. Essentially, this splits the top two buckets of Chart 1 into ten. The results are shown in Chart 2.
While there is a general pattern of large cap stocks outperforming the smaller cap stocks, one thing that jumps out is the significance of the largest decile of stocks. In fact, it was the only decile to have a higher average return than that of the R1000 benchmark for both the early and late period (bucket 8 was marginally positive for the early period).
We know that the capitalization distribution is highly skewed in the R1000, and that cap-weighted performance is sensitive to the distribution of capitalization. To give a more neutral indication of the importance of the largest stocks (decile 10) in Chart 3, we show the percentage of each deciles stock’s market capitalization that outperformed the R1000 benchmark.
For example, the chart shows that the sum of the capitalization of stocks in bucket 2 (the second smallest capitalization bucket) that outperformed the benchmark was approximately 20% of the benchmark capitalization in that bucket. What stands out again is the influence of the largest stocks. Approximately 71% of the capitalization of the largest 100 stocks outperformed the benchmark in the later period.
In conclusion, the first quarter factor performance of the Russell 1000 was heavily influenced by the Size factor. However, the Size effect was not consistent across the capitalization spectrum. The Size effect within the Russell 2000 was rather weak. More interesting is that the Size effect in the sell-off period after February 19 was dominated by the largest caps outperforming.
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