Our personal finance blogosphere tends to focus on picking and investing in local stocks. This is understandable given that we have a tax-friendly regime and it makes sense to make full use of this home advantage, especially with REITs.
And if you look the STI ETF (Index fund for the Singaporean stock exchange), it hasn’t seen much growth in the past decade.
To be fair, this isn’t that bad, as we could dollar cost average and take advantage of the lower price by accumulating more shares during this period of market stagnation. And dividends would also make up for the poor market performance.
But if you look at the S&P 500, over the past 2 decades are a different story:
Source: Google Finance “NYSEARCA:SPY”
There is no mystery here. Simply; the U.S. stock markets have companies like Apple, Facebook, GM, P&G trading, which are billion dollar behemoths (trillion dollar in case of Apple) with a presence in virtually every country.
STI on the other hand is heavily weighted in favour of local banks with some regional exposure, and Singapore is a small market.
International exposure however, is an easy way to diversify your exposure, given the U.S. is the world’s most developed stock market (~43% of the world’s stock market in 2018), and the growth engines of global trade can be found in China, Africa and SEA (Source).
Guessing which countries/regions/industries will be the right play for the next 10 years is always difficult and speculative, at best. As such, broad market ETFs by reputable fund providers with rock bottom costs (e.g. IEMG, EEM, VWO for Emerging markets) have been a staple of the savvy, long term, investor. These track indexes and aim to deliver a market return.
The S&P 500 is perhaps the most popular index, and frequently the target of ‘overbought.’ Fundamentally, this means disproportionate amounts of money flow into the companies in the index. Now we have more variants of the S&P 500 ETFs that could boost returns for investors.
Nobel-prize winner, Eugene Fama, together with his research colleague, Kenneth French, discovered that you can increase your returns if you buy cheaper and smaller cap stocks over a period of time. “The Cross-Section of Expected Stock Returns” which was published in the Journal of Finance in 1992 became the driver of the Factor-based Investing research. Today there are a lot more Factors being validated by the academia around the world.
Hedge Fund Managers, other financial professionals and investors have used some of these Factors even before they were ‘discovered’ by academia.
The smart-beta ETFs have commercialised Factors and make it available for retail investors to partake in.
We have already established that SPY has been a fantastic index ETF to own in the past decade. What if we can apply the Factors to increase the returns and yet buy the same 500 stocks in the index? A rational person would agree it is a good idea.
We know that the S&P 500 is a market-weighted index which means that bigger companies get a larger representation in the index. For example, Apple Inc. and News Corp represented 4.2% and 0.02% of the index respectively, reflecting their relative size of these two companies.
What if we redistribute this weightage? Buy more of the smaller companies and less of the larger companies. We inadvertently applied the Size Factor if we do this. Fama and French would say that our potential returns would increase.
Is that true?
An early version of the SPY was the Invesco S&P 500® Equal Weight ETF (RSP). RSP invests in the same 500 companies as with SPY, with a twist – the allocation to each stock is equal in the portfolio, unlike the original market-weighted allocation. This means that more money are invested in smaller companies within the S&P 500 Index.
Here’s the performance since 2003, with the RSP achieving 272% returns, beating the SPY returns of 191%. So Size Factor works!
Source: Yahoo! Finance
A New Variant: RVRS
The description from their official website is clear enough to explain this new ETF:
“The Reverse Cap Weighted U.S. Large Cap ETF (Ticker: RVRS) provides exposure to the companies in the S&P 500 index. However, while traditional market cap weighted indexes such as the S&P 500 weight companies inside the index by their relative market capitalization, RVRS does the opposite, weighting companies by the inverse of their relative market cap. By investing smallest-to-biggest, the fund is tilting investment exposure to the smaller end of the market cap spectrum within the large cap space.
• Reverse cap weighting tilts large cap exposure to the smaller end of the size spectrum. Studies have shown that while more volatile, smaller stocks can have outsized returns.
• Reverse cap weighting provides a less concentrated distribution of stock weightings, increasing overall diversification.
• Reverse cap weighting results in a weighted average market cap that is both significantly lower than market cap weighted large cap funds, and significantly higher than mid cap funds. Portfolios that allocate to market cap weighted versions of large, mid and small cap now have a tool to gain exposure to a sizeable gap in their holdings.”
RVRS is going one step further than RSP, by weighting more on the smaller companies instead of just an equal allocation.
By the principle of Size Factor, RVRS is supposed to perform better than RSP over time. We cannot prove that now since RVRS is barely even one year old, so there isn’t sufficient track record. But theory would say that the returns should be in this pecking order: RVRS > RSP > SPY.
Benchmarking with SPY
Here’s a comparison of the top 10 holdings between RVRS and SPY.
|Top 10 holdings|
|RVRS||Weight %||SPY||Weight %|
|Scana Corp||0.74||Apple Inc||4.20|
|Assurant Inc||0.73||Microsoft Corp||3.47|
|Brighthouse Financial Inc||0.68||Amazon Inc.||3.13|
|Envision Healhtcare Corp||0.68||Facebook Inc.||1.83|
|Stericycle Inc||0.65||Berkshire Hathaway Class B||1.66|
|Campbell Soup Co||0.65||JPMorgan Chase & Co.||1.65|
|Leggett & Platt Inc||0.64||Alphabet Inc. Class C||1.56|
|Newfield Exploration Co||0.64||Alphabet Inc. Class A||1.55|
|Flowserve Corp||0.62||Johnson & Johnson||1.45|
|TripAdvisor Inc||0.59||Exxon Mobil Corp||1.41|
|Total Top 10 weighing||6.62||Total Top 10 weighing||21.91%|
Let’s look at some metrics between RVRS and SPY in the table below.
|Dividend Yield – TTM||Not available yet||1.75%|
It is not a surprise as that RVRS’s PB and PE ratios are lower than SPY. Smaller cap stocks tend to be cheaper too due to lower demand from investors. Hence, going small would also mean you get exposed to the Value Factor. Size and Value usually come together.
Second thing to note is that RVRS has just been launched and the fund size is small, less than $10m. SPY is the largest ETF in the world with close to $300b assets under management (AUM)! Hence SPY can afford an extremely low expense ratio due to the economies of scale. RVRS would be able to reduce the fees if the ETF grows in popularity and their AUM goes up.
The risk of a small ETF is that the manager may decide to close shop one day. But fret not, you would get back your money after the stocks are liquidated.
$RVRS offers a way to arbitrage the wave of investment in passive funds, most notably the S&P 500. It does this by reverse weighting the components of the S&P 500. So, the smaller market cap companies, would be allocated a larger investment. This, as a whole, is a Size Factor play, with the ‘edge’ that the potential returns should be more promising than either SPY or RSP.
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