Analysis of Wasatch Micro Cap Fund
analysis, mutual fund

A recent story in Barron’s features the Wasatch Micro Cap Fund (WMICX). This $323 million no-load micro-cap growth fund has a 1.67% net expense ratio (currently subject to a contractual limit) and 31% turnover. According to the article

The fund’s 31% return over the past year beat 92% of small-cap growth rivals, according to Morningstar. And over the past three years, the average annual 14% return beat 85% of rivals— and the Russell Microcap Index, by about three percentage points.

The fund’s prospectus benchmark is the Russell Microcap® Index. One of the investable implementations of this index is the iShares Micro-Cap ETF (IWC). Alpholio™ calculations indicate that over the 10 years through September, the fund returned more than the ETF in about 45% of all rolling 36-month periods, 47% of 24-month periods and 53% of 12-month periods. The median cumulative (not annualized) underperformance of the fund over a rolling 36-month period was 0.57%.

Rolling Returns for Wasatch Micro Cap Fund (WMICX) and iShares Micro-Cap ETF (IWC)

A rolling returns comparison provides insights into relative returns of the fund over typical holding periods. However, it does not take the fund’s volatility or exposures into consideration. To account for these aspects, let’s employ Alpholio™’s patented methodology. In the simplest variant, it constructs a fixed-membership and weight ETF portfolio that most closely tracks periodic returns of the analyzed fund.

Here is the resulting chart with statistics of cumulative RealAlpha™ for Wasatch Micro Cap Fund over the past 10 years (to learn more about this and other performance measures, please visit our FAQ):

Cumulative RealAlpha™ for Wasatch Micro Cap Fund (WMICX)

The fund significantly underperformed its reference ETF portfolio of comparable volatility. The fund’s RealBeta™, measured against a broad-based market ETF, was elevated.

The following chart with related statistics shows the constant composition of the fund’s reference ETF portfolio:

Reference Weights for Wasatch Micro Cap Fund (WMICX)

The fund had equivalent positions in the iShares Russell 2000 Growth ETF (IWO), aforementioned IWC, First Trust Dow Jones Internet Index Fund (FDN), and iShares U.S. Medical Devices ETF (IHI). These ETFs represent average exposures of the fund over the analysis period.

The following chart with associated statistics depicts the fund’s performance relative to IWO, the dominant ETF in its reference portfolio, using the conventional capital asset pricing model (CAPM):

CAPM for Wasatch Micro Cap Fund (WMICX) on iShares Russell 2000 Growth ETF (IWO)

Although the fund’s beta coefficient was lower than one, it produced a negative alpha intercept. However, with the absolute value of t-statistic less than two, the intercept was not statistically significant.

The final chart with accompanying statistics compares the fund’s traditional performance measures to those of its benchmark ETF:

Total Return of Wasatch Micro Cap Fund (WMICX) and iShares Micro-Cap ETF (IWC)

Except for a lower volatility, the fund’s characteristics were very similar to those of the ETF.

In sum, over the past 10 years the Wasatch Micro Cap Fund failed to outperform its reference ETF portfolio or add meaningful value over a market-cap ETF. In addition, over the past three years, the fund had long-term capital gain distributions ranging from 4.5% to 16.4% of its net asset value (NAV), which made it largely unsuitable for taxable accounts.

To learn more about the Wasatch Micro Cap and other mutual funds, please register on our website.


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Analysis of Dodge & Cox Stock Fund
analysis, mutual fund

A recent story in the New York Times features the Dodge & Cox investment firm and its Stock Fund (DODGX). This $68 billion no-load large-cap fund sports a competitive 0.52% expense ratio and a low 16% turnover. According to the article

Over the past three years, the firm’s main fund, Dodge & Cox Stock, has returned just over 8 percent, trailing the Standard Poor’s 500 index by 1.5 percent during this period… The Dodge & Cox Stock fund’s five-year performance has been better. While many large capitalization mutual funds have struggled to keep pace with the surging Standard & Poor’s 500-stock index, which returned 14.2 percent, annualized, through September, Dodge & Cox Stock was up 15.6 percent.

Instead of the relatively short three- and five-year periods, this analysis will use a longer ten-year period through September 2017, which spans the 2008-09 financial crisis. The fund’s prospectus benchmark is the S&P 500® Index. One of the accessible low-cost implementations of this index is the SPDR® S&P 500® ETF (SPY). Alpholio™ calculations indicate that the fund returned more than the ETF in just 40% of all rolling 36-month periods, with a median cumulative (not annualized) return difference of negative 3.06%:

Rolling 36-Month Returns of Dodge & Cox Stock Fund (DODGX) and SPDR® S&P 500® ETF (SPY)

In contrast to our previous post covering the fund, this one will use a simpler variant of the patented Alpholio™ methodology. In this approach, both the membership and weights of ETFs in the reference portfolio are fixed over the entire analysis period. To make the fund substitution practical, the reference portfolio will contain no more than three ETFs.

Here is the resulting chart with statistics of the cumulative RealAlpha™ for Dodge & Cox Stock (to learn more about this and other performance measures, please consult our FAQ):

Cumulative RealAlpha™ for Dodge & Cox Stock Fund (DODGX)

The fund added a modest amount of value on a risk-adjusted basis, but did so mostly over only the past year or so. However, the fund’s volatility (measured as standard deviation of monthly returns) was higher than that of the reference ETF portfolio. The fund’s RealBeta™, measured against a broad-based equity ETF, was greater than one.

The following chart with associated statistics shows the constant composition of the reference ETF portfolio for the fund:

Reference Weights for Dodge & Cox Stock Fund (DODGX)

The fund had equivalent positions in the iShares S&P 100 ETF (OEF), PowerShares Dynamic Media Portfolio (PBS), and iShares U.S. Insurance ETF (IAK). These ETFs embody average exposures of the fund over the evaluation interval.

With the dominant ETF in the reference portfolio (OEF) as benchmark, the fund produced a negative alpha in the CAPM:

CAPM for Dodge & Cox Stock Fund (DODGX) and iShares S&P 100 ETF (OEF)

Finally, the fund failed to outperform both the SPY and OEF in terms of traditional measures, i.e. the annualized return, volatility, alpha and beta, or Sharpe and Sortino ratios:

Total Return of Dodge & Cox Stock Fund (DODGX), iShares S&P 100 ETF (OEF) and  SPDR® S&P 500® ETF (SPY)

In sum, the Dodge & Cox Stock Fund produced unimpressive results when compared to a simple ETF portfolio or even a single ETF. Despite a low turnover, in the late 2016 and early 2017 the fund had significant capital gain distributions, which made it less suitable for taxable accounts. It should also be noted that up to 20% of the fund’s assets may be in securities of foreign issuers, which affects the asset allocation in the overall investment portfolio.

To learn more about the Dodge & Cox Stock and other mutual funds, please register on our website.


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Analysis of Alger Small Cap Focus Fund
analysis, mutual fund

A recent piece in Barron’s features the Alger Small Cap Focus Fund (AOFAX; Class A shares). This small-cap growth fund has a 5.25% maximum sales charge, 1.20% net expense ratio and 76% turnover. According to the article

The now $537 million fund has returned an average of 10.9% a year over [the current manager’s] tenure, better than the 8.7% for the Russell 2000 Growth index.

The current manager took over the fund in mid-February 2015. Therefore, the following analyses will cover the period from March 2015 onward.

The fund’s prospectus benchmark is the Russell 2000® Growth Index. One of the investable implementations of this index is the iShares Russell 2000 Growth ETF (IWO). Alpholio™ calculations indicate that the fund returned more than the ETF in 75% of all rolling 12-month periods with a median cumulative (not annualized) outperformance of about 2.2% per period:

Rolling 12-Month Returns for Alger Small Cap Focus Fund (AOFAX) and iShares Russell 2000 Growth ETF (IWO)

The rolling return comparison assesses the fund’s relative performance over a holding period but does not take into account its exposures or risk. To gain insight into the latter, let’s apply the simplest variant of Alpholio™’s patented methodology. This approach constructs a reference ETF portfolio whose periodic returns most closely track those of the fund. Both the membership and weights of ETFs in the reference portfolio are fixed over the entire evaluation period. To make replication practical, the membership of the reference portfolio cannot exceed a preset number of ETFs.

Here is the resulting chart of cumulative RealAlpha™ for Alger Small Cap Focus (to learn more about this and other performance measures, please visit our FAQ):

Cumulative RealAlpha™ for Alger Small Cap Focus Fund (AOFAX)

The fund underperformed its reference portfolio of up to six ETFs: it returned less and with higher volatility. (A limit of six ETFs was used to arrive at a more complete picture of the fund’s exposures. Even when the reference portfolio contained just two or three ETFs, the outcome was similar.)

The following chart with statistics shows the constant composition of the reference ETF portfolio:

Reference Weights for Alger Small Cap Focus Fund (AOFAX)

The fund had major equivalent positions in the aforementioned IWO, iShares North American Tech-Software ETF (IGV), iShares U.S. Medical Devices ETF (IHI), PowerShares S&P SmallCap Health Care Portfolio (PSCH), SPDR® S&P® Biotech ETF (XBI), and Global X Social Media ETF (SOCL). These ETFs represent average exposures of the fund over the analysis period.

Finally, let’s examine the risk-adjusted performance of the fund against it dominant equivalent position, IWO, using a traditional model:

CAPM for Alger Small Cap Focus Fund (AOFAX) and iShares Russell 2000 Growth ETF (IWO)

The CAPM reveals that although the fund generated a positive alpha vs. the ETF, this intercept was not statistically significant, i.e. its t-stat was well below two. Please keep in mind that this simple, single-factor model does not fully adjust for the fund’s risks.

Under current management, the Alger Small Cap Focus Fund did not add value when compared to its reference ETF portfolio. The fund’s steep front load further detracted from its appeal. The fund currently has only 49 positions, concentrated at about 40% each in the health care and information technology sectors. The P/E and P/B ratios of the fund are approximately twice those of its benchmark index, which suggests that the fund may be highly susceptible to a market correction.

To learn more about the Alger Small Cap Focus and other mutual funds, please register on our website.


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Introducing CAPM Service
analysis

The latest service on the Alpholio™ patent-based analytical platform implements the capital asset pricing model (CAPM). Specifically, the service calculates the security characteristic line (SCL) with related statistics. In addition, the service provides statistics for the difference between periodic returns of the analyzed and reference securities.

In contrast to the traditional CAPM, which uses a theoretical market portfolio as a reference, the service allows the use of any available security. This has a practical implication of comparing concrete investment vehicles as opposed to evaluating a real security against an uninvestable “market” index, such as the S&P 500®. However, in both cases the reference is a single factor, whose periodic returns try to explain the returns of the analyzed security.

To demonstrate the service in action, let’s analyze the Vanguard Health Care Fund (VGHCX, Investor Shares; VGHAX, Admiral Shares). We covered this fund in one of the previous posts. This analysis will begin in January 2013, when the fund was fully taken over by its current manager.

Here are the fund’s exposures through June 2017, derived from the Fund Analysis service:

Reference Weights for Vanguard Health Care Fund Investor Shares (VGHCX)

The fund had equivalent positions in the Guggenheim S&P 500® Equal Weight Health Care ETF (RYH), iShares Global Healthcare ETF (IXJ) and iShares U.S. Pharmaceuticals ETF (IHE). Collectively, these positions formed a reference ETF portfolio with volatility comparable to that of the fund.

Let’s use the Total Return service to determine which of these three ETFs most closely tracked the fund’s returns over the same period:

Total Return of Vanguard Health Care Fund Investor Shares (VGHCX) and Reference ETFs (RYH, IXJ and IHE)

As could be expected, RYH, the ETF with the dominant weight in the reference portfolio, turned out to be the best fit. Therefore, let’s choose this ETF as a CAPM reference for the fund, using excess (i.e. net of risk-free rate) monthly returns of both securities:

CAPM for Vanguard Health Care Fund Investor Shares (VGHCX) and Guggenheim S&P 500® Equal Weight Health Care ETF (RYH)

The beta coefficient of the fund vs. the ETF was somewhat below one, a result of the slightly lower standard deviation (see statistics below the Total Return chart) and the 0.959 correlation coefficient (separately obtained from the Correlation service). With the t-statistic much higher than two, the beta coefficient was statistically significant. The alpha intercept, while positive, was not statistically significant. With the R-squared of almost 92, the regression fit was quite good.

Here is the expanded bottom panel of statistics:

Return Difference Statistics for Vanguard Health Care Fund Investor Shares (VGHCX) and Guggenheim S&P 500® Equal Weight Health Care ETF (RYH)

The mean difference between monthly returns of the fund and the ETF was slightly negative and had a substantial standard deviation. The low t-statistic indicated that the return difference was not statistically significant. By this measure, any value subtracted by active management of the fund could be attributed to bad luck and not a lack skill. If performance of the fund and the ETF were unchanged, it would take almost 212 years for the return difference to become statistically significant (and still be negative).

Since the fund had a considerable portion of its assets in foreign equities, IXJ could also be a relevant CAPM reference:

CAPM for Vanguard Health Care Fund Investor Shares (VGHCX) and iShares Global Healthcare ETF (IXJ)

In this case, the alpha intercept was large and statistically significant, although the R-squared was slightly lower. Similarly, the average return difference was a positive 0.35% and was statistically significant, requiring only 3.1 years to become so (statistics not shown here for brevity). This underscores that the choice of an appropriate reference security is critical because the CAPM regression uses only a single explanatory variable.

To try the new CAPM service, please register on our website.


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Analysis of Baron Asset Fund
analysis, mutual fund

A recent story in Barron’s covers the Baron Asset Fund (BARAX; Retail class shares). This $3 billion, mid-cap fund has a 1.31% expense ratio and 13% turnover. According to the article

Over the past five years, the fund returned 15% a year on average, better than 84% of its Morningstar mid-cap growth peers.

The current manager took over the fund in late January 2008. Therefore, the following analyses will start in February 2008, the first full month under sole management.

The primary prospectus benchmark for the fund is the Russell Midcap Growth Index. One of the long-lived and accessible implementations of this index is the iShares Russell Mid-Cap Growth ETF (IWP). Alpholio™ calculations indicate that through June 2017 the fund returned more than the ETF in only 32% of all rolling 36-month periods, 39% of 24-month periods and 38% of 12-month periods.

Rolling 36-Month Returns of Baron Asset Fund (BARAX) and iShares iShares Russell Mid-Cap Growth ETF (IWP)

The median cumulative (not annualized) underperformance over a rolling 36-month period was 3%.

In contrast to our earlier post about the fund, this analysis will use a simpler variant of the patented Alpholio™ methodology, in which both the membership and weights of ETFs in the reference portfolio are fixed. Here is the resulting chart of the cumulative RealAlpha™ with statistics for Baron Asset:

Cumulative RealAlpha™ for Baron Asset Fund (BARAX)

With a comparable volatility, the fund cumulatively underperformed its reference ETF portfolio by over 52%.

The following chart with related statistics illustrates the constant composition of the reference ETF portfolio (the membership was limited to a maximum of six ETFs):

Reference Weights for Baron Asset Fund (BARAX)

The fund had major equivalent positions in the Consumer Discretionary Select Sector SPDR® Fund (XLY), iShares Morningstar Mid-Cap Growth ETF (JKH), iShares S&P Small-Cap 600 Growth ETF (IJT), First Trust US Equity Opportunities ETF (FPX), Guggenheim Insider Sentiment ETF (NFO), and iShares U.S. Medical Devices ETF (IHI). These positions constituted average exposures the fund generated over the entire analysis period. They should be viewed in the context of the overall investment portfolio of which the fund may be part.

The final chart with traditional statistics compares the total return of Baron Asset to that of the aforementioned IWP and JKH:

Total Return for Baron Asset Fund (BARAX), iShares Russell Mid-Cap Growth ETF (IWP) and iShares Morningstar Mid-Cap Growth ETF (JKH)

The fund performed similarly to JKH (best-fit mid-cap ETF) but underperformed IWP (benchmark mid-cap ETF). Despite a relatively low turnover, in each of the past four years the fund had significant long-term capital gain distributions, which made it much less tax-efficient than these two ETFs. At the end of August, the fund held only 55 equity positions, with top-ten holdings accounting for almost 43% of assets. Divesting just a few of these positions could result in additional large distributions.

In sum, under current management the Baron Asset Fund did not outperform the available investment alternatives on a risk-adjusted basis. Any value added was consumed by a sizeable management fee.

To learn more about the Baron Asset and other mutual funds, please register on our website.


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