Analysis of long-term record suggests that style drift contributed to last year's performance
A well-known problem in the investing world is style drift, wherein a fund that supposedly follows a particular factor deviates from its stated approach — sometimes leading to disastrous results. And based on one analysis from S&P 500, that’s what’s been happening in the mid-cap fund space over the past few years.
In a recent blog post, Craig Lazzara, managing director and global head of Index Investment Strategy at S&P Dow Jones Indices, noted that 68% of mid-cap managers outperformed their benchmark S&P MidCap 400 Index last year.
“In fact, a majority of midcap managers outperformed in each of the past three years,” Lazzara said, citing data from SPDJI. “In those same years, an average of 66% of large cap managers underperformed the S&P 500.”
It’s possible that pricing inefficiencies in the mid-cap space and managers’ superior stock selection could be allowing their relative outperformance. But over the 10 years ended December 31, 2019, 84% of mid-cap managers lagged their index benchmark.
“We argue instead that style drift – for example, the ability of a midcap manager to buy large cap stocks – can shed light on mid- and small-cap managers’ success,” Lazzara said.
He noted that last year, the large-cap S&P 500 index rose 31.5%, whereas the S&P MidCap 400 achieved a more modest 26.2% gain. Any manager who crept up to the higher rungs of the capitalization ladder, therefore, could have benefited.
Based on SPDJI data from 2000 until last year, Lazzara said that mid-cap managers performance improved when the S&P 500 bested the S&P 400. The success rate of most mid-cap managers against the S&P 400 was 32% over the period; that figure rose to 57% when the S&P 500 outperformed its mid-cap counterpart, and fell to 17% when they S&P 500 lagged.
A similar type of style arbitrage was also apparent among large-cap managers. According to Lazzara, midcaps beat large caps in each of the three years during which most large-cap managers outperformed the S&P 500, indicating that large-cap managers might have boosted their performance by favouring the lower portion of the cap scale.
“So far in 2020, of course, the S&P 500 is well ahead of its smaller counterparts; mid- or small-cap managers might well benefit in next year’s SPIVA data,” he said. “Such opportunistic moves may be commendable, but they are not evidence of skill at stock selection.”
