Analysis of Invesco Small Cap Equity Fund
analysis, mutual fund

Today’s piece in Barron’s profiles the Invesco Small Cap Equity Fund (SMEAX, Class A shares). This $1.45 billion fund has a maximum 5.5% sales charge, a 1.29% expense ratio and a 45% turnover. According to the article

… [the] fund has, for the past decade, outperformed 73% of small-blend funds with less risk than 75% of that group.

The fund’s style-specific benchmark is the Russell 2000® Index. One of the practical, long-lived implementations of this index is the iShares Russell 2000 ETF (IWM). Alpholio™’s calculations show that since September 2004 (the start month of the current manager), the fund returned more than the ETF in about 47% of all rolling 12-month periods, 48% of 24-month periods, and 62% of 36-month periods. However, this type of comparison to a single benchmark does not adequately account for the fund’s risk or composition (the article mentions a 92% active share).

To adjust for these factors, let’s apply a variant of Alpholio™’s patented methodology in which both the ETF membership and weights do not change over the entire analysis period. Here is the resulting chart of cumulative RealAlpha™ and related statistics for Invesco Small Cap Equity:

Cumulative RealAlpha™ for Invesco Small Cap Equity Fund (SMEAX)

Since September 2004, the fund produced a negative 0.61% of regular and negative 0.42% of lag annualized RealAlpha™ (to learn more about RealAlpha™, please visit our FAQ). These statistics do not take the fund’s front load into account. At 17.76%, the fund’s standard deviation was slightly higher than that of the reference portfolio. Underscoring the fund’s volatility was the RealBeta™ of 1.12.

The following chart shows the constant-weight membership of the reference portfolio for the fund:

Reference Weights for Invesco Small Cap Equity Fund (SMEAX)

The fund had top equivalent positions in the above-mentioned iShares Russell 2000 ETF (IWM; constant weight of 27.4%), iShares S&P Small-Cap 600 Growth ETF (IJT; 16.5%), iShares Russell 2000 Growth ETF (IWO; 16.3%), iShares S&P Mid-Cap 400 Growth ETF (IJK; 7.2%), iShares Morningstar Small-Cap ETF (JKJ; 7.2%), and iShares S&P Small-Cap 600 Value ETF (IJS; 6.3%). The fixed-income holdings of the fund were collectively represented by a 5.1% position in the iShares 1-3 Year Treasury Bond ETF. The reference portfolio was rounded out by three additional ETFs with smaller weights.

Under current management, the Invesco Small Cap Equity Fund could have effectively been substituted, and with better risk-adjusted performance, by a fixed portfolio of a handful of small-cap ETFs. After accounting for a substantial front load, the fund’s would subtract even more value. An addition, the fund’s relatively large distributions (14.6% of the NAV in 2014; 6.5% in 2013) made it more suitable for non-taxable investment accounts.

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

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Analysis of Vanguard Health Care Fund
analysis, mutual fund

Today’s profile in Barron’s features the Vanguard Health Care Fund (VGHCX, Investor shares; VGHAX, Admiral shares). This actively-managed $52.7 billion sector fund has a very competitive 0.34% expense ratio and a relatively low 20% turnover. According to the article, the founding long-term manager of the fund taught the current manager well, and

That foundation has helped [her] guide the fund to a 30.8% average annual return over the three years ended on July 29—6.4 percentage points better than the category benchmark, the MSCI All Country World Health Care index.

Given a 4.5-year overlap between the two managers, the remainder of this analysis will focus on the entire tenure of the current manager, i.e. a period starting in June 2008 (the first full month on board).

The prospectus benchmark for the fund is the MSCI ACWI Health Care Index. There are currently no ETFs that track this index; the closest approximation is the iShares Global Healthcare ETF (IXJ). Alpholio™’s calculations show that the fund returned more than the ETF in about 80% of all rolling 12-month periods, 82% of 24-month periods, and 96% of 36-month periods. Given that the fund has a majority of its holdings in U.S. equities, a domestic health care sector ETF may be considered as an alternative reference. When the iShares U.S. Healthcare ETF (IYH) is used for that purpose, these figures are 62%, 68% and 48%, respectively. However, in either case a single ETF does not adequately adjust for the fund’s risk.

In the simplest variant of Alpholio™’s patented methodology, a custom portfolio of ETFs with fixed membership and weights is constructed as an alternative to the analyzed fund. For the Vanguard Health Care fund in the above analysis period, such a portfolio had top-four positions in the Health Care Select Sector SPDR® Fund (XLV; constant weight of 37.2%), iShares Global Healthcare ETF (IXJ; 20.4%), Guggenheim S&P 500 Equal Weight Health Care ETF (RYH; 17.2%), and iShares U.S. Pharmaceuticals ETF (IHE; 9.5%). At about 13.6%, the fund’s standard deviation (a measure of volatility of returns) was only 0.2% higher than that of the reference portfolio. The fund produced about 2.5% of annualized RealAlpha™ and had a RealBeta™ of 0.66.

In a more elaborate approach, Alpholio™ builds a dynamic portfolio of ETFs with fixed membership but variable weights. Here is a resulting chart of the cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for Vanguard Health Care Fund (VGHCX)

On a risk-adjusted basis, the fund added almost all of its value only in the last two and a half years. Over the entire seven-year period, the annualized standard deviation was 13.6% compared to 12.9% for the reference portfolio. The annualized regular RealAlpha™ was 3.25% and the lag RealAlpha™ 4.16% (to learn more about RealAlpha™, please visit our FAQ). The RealBeta™ was 0.636.

The following chart shows weights of ETFs in the reference portfolio for the fund over the same analysis period:

Reference Weights for Vanguard Health Care Fund (VGHCX)

The fund had only six equivalent positions: in the Vanguard Health Care ETF (VHT; average weight of 54.4%), iShares Global Healthcare ETF (IXJ; 28%), iShares 7-10 Year Treasury Bond ETF (IEF; 7.6%; representing the fixed-income holdings), iShares MSCI Japan ETF (EWJ; 5.7%), Vanguard Utilities ETF (VPU; 2.3%; also representing fixed-income investments), and iShares North American Tech-Software ETF (IGV; 2%; helping explain the remainder of the fund’s returns).

Under current management, the Vanguard Health Care fund had impressive risk-adjusted returns. However, most of the value was added only in the most recent one-third of the seven-year analysis period. The fund’s comparatively low expense ratio can be reduced even further to 0.29% by investing in the Admiral shares. The fund is characterized by a relatively low volatility of returns and held up well in the last major market downturn in 2008. The fund’s significant distributions, even though mostly in the form of long-term capital gains, make it more suitable for non-taxable accounts.

To learn more about the Vanguard Health Care and other mutual funds, please register on our website.

Disclaimer: Due to a multitude of random factors, perfect prediction of performance of an investment vehicle is nearly impossible. Therefore, the above analysis should be treated as merely one of the many inputs to an investment decision, and not as a definitive recommendation to buy or sell any securities. While Alpholio™ strives to provide original and useful insights into fund and portfolio performance, the ultimate investment decision belongs to you, the investor.

For a detailed explanation of Alpholio™’s patented analysis methodology, please refer to the FAQ.

© 2015 Envarix Systems Inc. All Rights Reserved.

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