Equity returns have been driven by a select number of mega-cap growth-oriented companies. (UBS)

So far in 2023, only quality has outperformed the S&P 500, and not by nearly enough of a margin to offset underperformance from the other factors. It’s very much the same old song and dance from the 2017–21 period, when most equity factors lagged the S&P 500. A full factor quilt including the annual performance of individual factors, a multifactor approach, and the S&P 500 going back is available in our Factor

performance presentation published 3 August 2023 (please consult your UBS financial advisor for the presentation).

As discussed in the blog from our equity strategy team, The surging seven, equity returns have been driven by a select number of mega-cap growth-oriented companies (Apple, Microsoft, Nvidia, Amazon, Meta, Tesla, and Alphabet). At the start of the year, the surging seven stocks accounted for roughly 20% of the S&P 500 and almost 47% of the Nasdaq-100. These companies accounted for more than 70% of the return of the S&P 500 in 1H23. Only 28% of stocks included the S&P 500 outperformed the index, which, according to our equity strategy team, is one of the lowest readings in their data going back to 1985. The narrow market leadership contributed to one of the worst six-month periods for the S&P 500 Equal Weight Index since its inception, as it lagged the S&P 500 by over 8 percentage points in 1H23. By comparison, the Nasdaq-100 Index, which is ultimately a mega-cap growth index, had one of its strongest six-month returns over this period, outperforming the S&P 500 by 19 percentage points.

Given the above backdrop, it’s not surprising that only 17% of active US large-cap core managers beat the S&P 500 index in 1H23. For US large-cap growth, only 33% of active managers were able to outperform. After all, taking advantage of factors is a lever that active managers can use to try to outperform traditional benchmarks that use market cap to select and weight securities. When describing their process, active managers often target companies that they believe are trading at attractive valuations (value orientation versus benchmark) and able to sustain the higher dividends, earnings growth rates, return on equity, or some sort of competitive advantage (quality). Also, by deviating away from market-cap weighting, an investment process will usually have a smaller size bias. Most of these tilts would have hurt performance. Finally, it's hard for active managers to be even further overweight the surging seven companies versus the S&P 500 or growth indices that market-cap weight securities, like the Russell 1000 Growth Index.

The narrow market trends in US large-cap equities that impacted active management performance were less prevalent in other equity markets. For example, smaller market caps where there was more dispersion had higher hit rates, with 52% of mid-cap value funds outperforming the Russell Mid Cap Value Index, and 74% of small value funds outperforming the Russell 2000 Value Index.

International equities also presented better prospects for outperformance, with 65% of foreign large-cap core funds outperforming, and 73% of diversified emerging market managers outperforming as China continued to decline in value.

But enough looking in the rear-view mirror. What do we expect going forward?

Within our equity strategy, we have a small tactical preference for US large cap value over US large-cap growth given that we’re neutral on the former and least preferred on the latter. As discussed in the blog History favors value, 1H23 was one of the worst periods for value versus growth. The Russell 1000 Value Index lagged the Russell 1000 Growth Index by 24 percentage points. However, history suggests that performance tends to reverse following periods of severe underperformance. And while we’re tactically neutral on US mid- and small-cap equities, relative valuations on smaller-size segments are attractive, setting up the potential for quite favorable returns over the next decade. If these views on value and smaller sized equities prove correct, there should be better days ahead for factor strategies and active equity manager performance over both a tactical and strategic horizon. Importantly, not all factor and active strategies are created equal.

Main contributors: Daniel J. Scansaroli, David Perlman, Christopher Buckley

Original report - Same old song and dance , 9 August 2023.