2017 Factor Alpha Newsletter

Categories Investing, OSAM Research

Based on our Factor Attribution Tool, we’ve seen size play a large contributing role to the 1st quarter’s performance,1 especially when staying within what we consider to be a “true” microcap space2 — that is, disallowing the portfolio to drift up the market cap scale into small caps. 

This Microcap 1Q17 edition of the Factor Alpha Newsletter (also see Small Cap 1Q17) puts our proprietary multi-factor themes3 up against the single-factor Russell Microcap® Index.4 The factors we choose for our themes are driven by strong fundamentals that work effectively over a full market cycle. Importantly — because in any given year an individual factor can do well or poorly, creating noise in the long-term process — using any of these factors and/or themes in isolation should be avoided. Instead, we suggest that investors use various hybrids of several multi-factor themes to build conviction-weighted high Active Share portfolios.

The following exhibits are live-time factor snapshots excerpted from our customized 1Q17 market commentary:5

To contextualize the performance of the themes shown further below, first we’ll isolate the difference in performance associated with the Russell Microcap benchmark’s market cap-weighted methodology versus an equal-weighted selection universe:

Size: “Market Cap-Weighted” less “Equal-Weighted”
(Cumulative excess returns, 1/1/17–3/31/17)

Next, the cumulative excess returns QTD (1/1/17–3/31/17) for the top deciles6 of each theme versus the entire universe of stocks in the benchmark:

OSAM Value

Stocks trading at large discounts to current sales, earnings, EBITDA, and Free Cash Flow.

OSAM Momentum

Stocks with impressive and stable recent total returns.

OSAM Financial Strength

Stocks that use debt responsibly, and aren’t overly reliant on outside financing.

OSAM Earnings Quality

Stocks with strong cash flows and conservative accounting.

Shareholder Yield

Stocks returning high amounts of cash to shareholders through dividends and buybacks.

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  1. Example: Our microcap strategy (see osam-microcap.com) focuses in on stocks ranging from $50M to $200M market cap at point of purchase. Russell’s Microcap benchmark currently ranges from $14M to $1.6B. Russell is scheduled to have its annual rebalance in May 2017, so it’s reasonable to presume that range will shrInk after the reconstitution. However, even Russell’s starting point for market cap range is a much broader definition. After their 2016 reconstitution, the market cap range was from $30M to $863M.
  2. Using the O’Shaughnessy Micro Cap portfolio of undervalued microcap companies with solid growth metrics as an example.
  3. We blend factors together to build proprietary multi-factor themes to help reduce the noise of any one factor, but even investment themes experience cyclical periods of underperformance.
  4. The Russell Microcap® Index measures the performance of the microcap segment of the U.S. equity market. It makes up less than 3% of the U.S. equity market. It includes 1,000 of the smallest securities in the small-cap Russell 2000® Index based on a combination of their market cap and current index membership.
  5. The multi-factor portfolios (themes) are calculated using a compositing methodology: Monthly portfolios are created with a 12-month holding period, then the 12 monthly portfolios are combined to create the composite portfolio.
  6. For example, Value’s top decile is “the cheapest 10% of stocks” within the universe.