Opinions about the prospects for equity investments are never hard to find at the start of the year, each supported by some presumptive analysis of past market outcomes.
Momentum buyers use recent returns to see what’s hot. Contrarians use the same information to identify reversals. Other views are drawn from long-term track records for fund managers, sectors or factors. Each view, therefore, is a naked bet on which part of history the current market resembles. Last year? Not last year? Every year?
Our questions: Which part of history matters? And how would today’s funds have fared during that period?
We turned to holdings-based analytics specialist Windfactor Research for insight.
President, Windfactor Investment Research
Research supports intuition: Periods with similar starting prices have seen consistently similar equity returns. These ‘best-match’ periods – typically not the recent past – vary by business type and over time as investors crowd into different areas of the market. There are many moving parts, so assessing the impact on equity funds requires jumping through a few statistical hoops, but with
fund holdings we can compute a few high-level fund statistics (see Windfactor ABCs) supported by a fair amount of underlying detail.
Assuming best-match conditions will prevail in 2018, here are three likely winners and three long shots drawn from our universe of US style, sector and factor ETFs.
iShares US Consumer Services ETF
It has a concentration in large-cap retailers and media that has historically paid off well from similar (bargain basement) prices. Windfactor: 91
iShares US Financials ETF
It has a focus on risky banks at the expense of many of the more attractive areas of the market. Windfactor: 12
iShares S&P Small-cap Value ETF
The fund’s underweight to long-term momentum stocks and overweight to numerous low valuation industries – ranging from apparel to wholesalers – has been a winning combination.
iShares S&P 500 Growth ETF
It is concentrated in big tech, funded by underweights in high revenue-per-dollar industrial, energy and consumer services firms.
iShares Edge MSCI USA Value Factor ETF
The fund takes big bets on retailers, motor vehicles and tech giant Apple, funded by underweights on pricey smaller and/or high-revenue growth firms.
iShares Edge MSCI USA Momentum Factor ETF
Holding a frothy mugful of last year’s winners has rarely paid off in this part of the cycle. Windfactor: 13
What they are: Windfactors measure the statistical probability (0 to 100) that a fund will outperform the US market over the next 12 months given past market conditions.How they’re built: The historical risk-adjusted returns of similar companies with similar starting prices, as calculated by Windfactor’s unique business factor models. These best-match returns are reported in percent relative to the broad US market.
Why we care: They predict actual fund returns whenever history repeats itself. Research suggests systematically investing in funds with higher Windfactors would have been a good bet over at least the past decade.