U.S. equity markets finished 2017 on a strong note, with the S&P 500® returning 21.83% during the one-year period ending on Dec. 31, 2017. This was followed by the S&P MidCap 400® and S&P SmallCap 600® returning 16.24% and 13.23%, respectively.
Despite market-cap weighting being a dominant form of indexing, equal weighting has outperformed on a cumulative basis over the past 28-year investment horizon. However, on a rolling one-year basis, 2017 was also the first time in about two years that equal weighting underperformed market-cap weighting (see Exhibit 1). In this blog series, we will discuss the impact that size (specifically mega-cap securities) had on the performance of U.S. equity indices in 2017.
Furthermore, we extend the size analysis to the active management space by quantifying the style and market-cap drift displayed by managers, and to what extent that drift influenced the performance of those actively managed funds. Finally, we present results comparing how the AUM size of managers affected their performance.
As a starting point, Exhibit 2 shows the contribution to return of the S&P Composite 1500® by market capitalization, divided into 20 distinct groupings so that each bucket has approximately 5% of the beginning index weight. The numbers on top of the bars represent the constituents represented in each group—as such it takes an increasing amount of companies (or share classes for those with duplicates) to reach the 5% threshold. In an environment where size is not the primary driver of returns, this chart would appear level across all data points.
We can observe that the top 5% group accounted for roughly 10% (2.2% divided by 21.13%) of the overall index return. Furthermore, the third-largest group accounted for an additional 10% of the headline return. Group 2, despite being larger in market cap compared with group 3, had a lower contribution to return, due to negative performance by one of its members. The contribution spread between the top three groups and the bottom three groups amounted to 3.13%. Hence, the data highlights that 2017 was a good year to be invested in mega-cap names, given that 10 securities comprising the top 15% (by weight) of the S&P 1500 Composite accounted for approximately 26% of the overall index return.
Furthermore, the S&P 100 and S&P 500 Top 50, which represent the largest 100 and 50 securities from the S&P 500 returned 21.96% and 23.28%, respectively. Given this nature of the U.S. equity market, in 2017, active managers investing in domestic equity could not afford to have large active underweights in those mega caps.
In the next blog, we will use the information presented here in tandem with data from the SPIVA® U.S. Year-End 2017 Scorecard to further understand the relative performance characteristics of active managers.