American consumers certainly seem to think the future looks bright. The University of Michigan’s Consumer Sentiment Index has been bouncing at the top end of its range recently, while the comparable Consumer Confidence Index has reached its highest levels since 2001. Statistically speaking, good times are on the way.
On the other hand, consumer-focused equity funds have lagged notably in the US market. For example, S&P 500 indexed funds have outperformed the iShares US Consumer Services ETF (IYC) by more than 6% since the lows of February 2016, and the iShares US Consumer Goods ETF (IYK) by a whopping 14.5%. Investors, it seems, have not equated consumer optimism with good fortune for consumer businesses.
Our question: Is there a buying opportunity here?
We turned to holdings-based analytics specialist Windfactor Research for insight into the prospects for these funds going forward.
Investors in sector funds make an implicit bet that stocks for companies in a few industries will outperform all others. The likelihood of such a result over the next year – assuming the market follows historical patterns – is relatively high for the US Consumer Services ETF, which currently boasts a Windfactor of 71. The odds for the US Consumer Goods ETF appear more balanced: its Windfactor is a more modest 54.
Both funds appear well-positioned relative to the iShares Core S&P 500 ETF (IVV), which, with a Windfactor of 26, looks unlikely to outperform funds with higher allocations to small and mid-caps stocks.
An equity fund’s Windfactor is the statistical probability of the fund outperforming the US market over the next 12 months, expressed as a value ranging between 0 if it is the benchmark and 100 if outperformance is ‘historically certain.’ Our research indicates that systematically investing in funds with higher Windfactors would have been a good bet over the past decade and will continue to be so if history keeps repeating itself.
Windfactors are derived from best-match returns, the average and volatility of historical one-year relative returns for similar companies during similar market environments. They leverage a unique business factor model that matches today’s companies with past firms based on criteria such as primary industry, earnings drivers, management policies and market value. Best-match returns are reported in percent relative to the Windfactor US Market Portfolio – a benchmark made up of the top 2,500 US securities by market cap.
Figure 1 shows the historical performance of IYK, IYC and IVV alongside their current best-match statistics. The analysis shows a tracking error versus the benchmark of 8.2% for IYC and 7.0% for IYK – both much higher than IVV’s 1.1%. However, IYC has enjoyed consistently higher average returns (4.6% versus just 0.6% for IYK), which explains its higher Windfactor.
Figure 2 shows the top three active industry factor weights for the iShares Consumer Goods and Consumer Services ETFs as of September 2017. These statistics show that investing in IYC is largely a bet on the relative returns of retailers like Amazon, while in the case of IYK the bets are on food and beverage producers such as Altria and Coca-Cola. These large overweights are offset by small underweights in most other factors.
Figure 3 shows the historical best-match returns as of September 2017 for the top industry factor bets, which illustrates the relationship between a fund’s bets on industry factors and its overall Windfactor. The statistics reflect strong best-match returns for all three of IYC’s top industry bets. For IYK, only food and beverage producers have consistently outperformed over similar periods, while results for the fund’s other two industry bets have been mixed.
These analytics notwithstanding, new things can happen at any time with equities. Changing business fundamentals can break past return patterns with lasting shifts in growth prospects. In the case of today’s consumer businesses, investors seem to believe that change is afoot, particularly in the case of retailers, where the shift to online shopping has upended the industry.
But are they right? Only time will tell.
Visit www.windfactor.com for additional research, test results and fund analysis.