Stratified SmallCap: Outperformance through Diversification

Following several years of underperformance, investors are showing a renewed interest for small cap stocks. The S&P SmallCap 600 index rose 31.3% in Q4 2020, outperforming the S&P 500 by 19.2%, its strongest quarterly outperformance since the index began in 1994. The Syntax Stratified SmallCap Index showed even stronger performance than its cap-weighted analog, rising 32.0% over the quarter (Exhibit 1). The strong performance could signal an investor preference for the growth potential of small cap companies, coupled with their reasonable valuations, especially relative to their large cap counterparts.

Stratified Weight is a diversified way to gain exposure to an asset class. By allocating across a wider range of business groups than cap-weighted benchmarks (which typically have concentrated positions in certain stocks and industries), Stratified Weight balances exposure to different types of businesses. This means the index has at least some allocation in the best performing segments, while not over-allocating to the worst performing ones and as such is designed to generate outperformance through diversification.

Exhibit 1. Performance of S&P 600 and Stratified SmallCap index

From a longer-term perspective, the recent outperformance of small caps represents a reversal in the S&P 500’s dominance since 2016, driven mainly by the outperformance of mega-cap tech stocks. A similar trend was seen in the late 1990s, before the DotCom bubble burst, and small caps consistently outperformed large caps over the following fifteen years (Exhibit 2).

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Exhibit 2. Performance of S&P 500 vs S&P SmallCap 600 index

From a longer-term perspective, the recent outperformance of small caps represents a reversal in the S&P 500’s dominance since 2016, driven mainly by the outperformance of mega-cap tech stocks. A similar trend was seen in the late 1990s, before the DotCom bubble burst, and small caps consistently outperformed large caps over the following fifteen years (Exhibit 2).

Exhibit 2. Performance of S&P 500 vs S&P SmallCap 600 index

The outperformance of small caps has the potential to persist given that it is supported by attractive relative valuations, similar to those seen at the height of the DotCom bubble (Exhibit 3).

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Exhibit 3. The S&P 600 trades at a historical discount to the S&P 500

On January 31st 2021, the S&P 500 was trading at 2.6x next-year’s sales, whereas the S&P 600 was trading at 1.1x, a 58% discount.

The Stratified SmallCap Index consistently trades on a lower multiple than the S&P 600, as its quarterly rebalancing schedule typically reweights away from those stocks and industries that have had the strongest performance over the quarter. On January 31st 2021, the Stratified SmallCap Index was trading at 0.8x next-year’s sales, a 69% discount to the S&P 500 and a 26% discount to the S&P 600.

Stratified SmallCap: Outperformance through Diversification

We believe that the outperformance of Stratified Weight versus Cap Weight within the small cap universe is a function of the weighting methodology (since the two indices are composed of the same securities, at different weights). The more diversified business risk exposure enabled the best performing sectors in Q4 (Consumer and IT) to have a significant weight in the index. Conversely, the worst performing sectors (Financials and Industrials) were not over allocated, unlike the S&P 600 (Exhibit 4).

Exhibit 4. S&P 600 has significant financials and industrials concentrations

Important Disclaimers
This document is for informational purposes only and is not intended to be, nor should it be construed or used as an offer to sell, or a solicitation of any offer to buy, any security. Additionally, the information herein is not intended to provide, and should not be relied upon for, legal advice or investment recommendations. You should make an independent investigation of the matters described herein, including consulting your own advisors on the matters discussed herein. In addition, certain information contained in this factsheet has been obtained from published and non-published sources prepared by other parties, which in certain cases have not been updated through the date hereof. While such information is believed to be reliable for the purpose used in this factsheet, such information has not been independently verified by Syntax and Syntax does not assume any responsibility for the accuracy or completeness of such information. Syntax LLC, its affiliates and their independent providers are not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein.

Past performance is no guarantee of future results. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The inception date of the Syntax Stratified SmallCap Index™ is January 3, 2020. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight. Charts and graphs are provided for illustrative purposes only.

Index performance does not represent actual fund or portfolio performance and such performance does not reflect the actual investment experience of any investor. An investor cannot invest directly in an index. In addition, the results actual investors might have achieved would have differed from those shown because of differences in the timing, amounts of their investments, and fees and expenses associated with an investment in a portfolio invested in accordance with an index. None of the Syntax Indices or the benchmark indices portrayed herein charge management fees or incur brokerage expenses, and no such fees or expenses were deducted from the performance shown; provided, however that the returns of any investment portfolio invested in accordance with such indices would be net of such fees and expenses. Additionally, none of such indices lend securities, and no revenues from securities lending were added to the performance shown.  

The Syntax Stratified SmallCap Index™ is the property of Syntax LLC, which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC) to calculate and maintain the Index. The Index is not sponsored by S&P Dow Jones Indices or its affiliates or its third-party licensors (collectively, “S&P Dow Jones Indices”). S&P Dow Jones Indices will not be liable for any errors or omissions in calculating the Index. “Calculated by S&P Dow Jones Indices” and the related stylized mark(s) are service marks of S&P Dow Jones Indices and have been licensed for use by Syntax. S&P® is a registered trademark of Standard & Poor's Financial Services LLC (“SPFS"), and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”).

Syntax®, Stratified®, Stratified Indices®, Stratified-Weight™, Stratified Benchmark Indices™, Stratified Sector Indices™, Stratified Thematic Indices™, Affinity™, and Locus® are trademarks or registered trademarks of Syntax, LLC and its affiliate Locus LP.