These 2 Factors Protected Clients’ Downside Last Year

By Chief Investment Officer, Chuck Self , and Marketing Analyst, Jordan Cornelius on March 5, 2019

2018 was the first true test for factors performance. The table below provides an analysis of the first three quarters (bull market), 4Q (bear market) and full year performance. It is instructive to analyze these numbers:

Sources: Invesco; iSectors


Where Did We Find Bear Market Protection?

The first category we’ll dive into is large cap, which had some very interesting performance in 2018. A specialized large cap growth index, the Dynamic Large Cap Growth Intellidex Index (highlighted in green in the table) was the only index that outperformed the S&P 500 in both parts of the year.  It also outperformed the standard S&P 500 Growth Index (not shown) which was flat for the year. The methodology evaluates companies quarterly, based on a variety of factors grouped into 5 broad categories: Price Momentum, Earnings Momentum, Quality, Management Action & Value.

The Invesco S&P 500 Pure Growth ETF (RPG) is based on the S&P 500 Pure Growth Index, highlighted in orange. It significantly outperformed the S&P 500 in the first three quarters and modestly underperformed in Q4. For the year it slightly outperformed the S&P 500 but was behind the standard S&P 500 Growth Index.

Next, we’ll look at the small cap factor, which failed last year. Although small caps, represented by the S&P SmallCap 600 Index, outperformed the S&P 500 in the first three quarters, it badly underperformed in the 4Q and therefore, the year.

Midcaps, represented by the S&P 400 MidCap 400 Index, underperformed the S&P 500 both in the bull and bear markets.

The low volatility indices (highlighted in yellow) were the big factor index winners in Q4. The S&P 500 Low Volatility and S&P MidCap 400 Low Volatility Indices slightly underperformed in the bull market but significantly outperformed in Q4 resulting in positive returns for the year.

Dividend indices (highlighted in blue) were also top performers in Q4. The Dow Jones Industrial Average Yield Weighted Total Return Index performed the best due to its slight underperformance in the bull market but fabulous results in the bear market.

The S&P 500 Low Volatility High Dividend Index, the basis for the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), had only one-half of the loss as S&P 500 in the 4th quarter, but tremendously underperformed the benchmark in the bull market. The NASDAQ Dividend Achievers Index, constructed similarly to the benchmarks for rising dividend holdings, also underperformed in the bull market but did not protect as well as the other dividend holdings in the last three months of the year. This is consistent with the previous research we have sited that high dividend funds perform better than dividend growers in bear markets.

Equal weight and momentum factors (including the Dorsey Wright indices) failed miserably last year. We have written about our belief that momentum (trend following) does not work over time. (Read article here.) It was proven again last year.

The multifactor indices (including the FTSE RAFI and the Dynamic Market Intellidex indices) lagged behind the market last year. Since they include factors that are not time-tested with real performance, this is not surprising. As indicated above, the Dynamic Large Cap Growth Intellidex Index was the notable exception.

At the bottom of the chart are the maximum and minimum values for each period along with the spread between the two values.

iSectors Equity Allocations Provided Downside Protection in the Fourth Quarter

In the chart below we added a few iSectors’ models to see how these compared during 2018. The models added are iSectors Post-MPT Growth Allocation, iSectors Domestic Equity Allocation and iSectors Global Equity Allocation.

The iSectors equity allocations provided protection in the 4Q. They will continue to focus on factors that perform well during bull markets and provide downside risk in bear markets. Both Post-MPT Growth and Domestic Equity had such small losses in Q4 that they outperformed the S&P 500 for the year even though they were behind on 9/30. Global Equity also protected against the market losses in the 4Q but still underperformed the S&P 500 for the year. It did outperform the MSCI ACWI index which had a performance of -8.93% for 2018.

Sources: Invesco, iSectors

To save you time and move you toward being an elite advisor, iSectors has equity allocations that incorporate factors that tend to perform well during bull markets and provide downside risk in bear markets.

The iSectors Global Equity Allocation model targets a diversified basket of low cost, domestic, emerging market, and developed international equity index ETFs. The portfolio also targets fundamentally-weighted index ETFs (where the underlying indexes are based on dividends, or other fundamental criteria rather than capitalization-weighted indexes) to enhance return and reduce volatility.   Approximately two-thirds of the Allocation is held in dividend funds. The portfolio is tilted toward small and mid-cap stocks compared to the standard global equity benchmark.

For those advisors looking for a U.S. version, the iSectors Domestic Equity Allocation model is a strategic model comprised exclusively of U.S. equity securities.  This model has a conservative, value-focused dividend overweighting (75% of the portfolio), which improves dividend yields while investing in financially healthy companies. Like the Global Equity Allocation, the portfolio is overweighted in small and mid-cap stocks which comprises 35% of the portfolio compared to 17% for the Russell 3000.

The iSectors Post-MPT Allocations seek investment returns that outperform their benchmarks with lower downside risk over a complete market cycle. Post-MPT Growth has a Standard & Poor’s 500 benchmark while Moderate is measured against a 60% S&P 500 stock market index and 40% Barclays Aggregate Bond Index combination. iSectors objectively allocates and rebalances the portfolio among up to 9 specific, low-correlated asset classes including long Treasury bonds and gold stocks. The mathematical process, utilized simultaneously by both Allocations, is guided by a series of proprietary economic and capital market factors.

If you are a financial advisor that wishes to learn more about creating a more effective equity portfolio, please contact Scott Jones at 800-869-5184 or [email protected].  Alternatively, you may review information on the iSectors Allocations described above as well as others by clicking over to our Allocations page. Individual investors can contact Scott Jones for a referral to a recommended iSectors advisor that can help them determine the best iSectors asset allocation for their portfolios.

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