Today’s piece in Barron’s profiles the Homestead Small-Company Stock Fund (HSCSX). This $1 billion no-load fund sports a relatively low 0.94% expense ratio and a rock-bottom 1% turnover rate. According to the article

The $1 billion fund returned an average of 12% over the past 15 years, beating 90% of funds in the small-blend category, according to Morningstar. The fund has beaten 98% of its peers over 10 years, and 96% over five.

The primary benchmark for the Homestead Small-Company Stock fund is the Russell 2000® index. One of the practical implementations of this index is the iShares Russell 2000 ETF (IWM). According to Alpholio™ calculations, over the past 14 years the fund returned more than the ETF in about 73% of rolling 12-month periods. The mean outperformance per period was about 4.1%. With the rolling period extended to 36 months, the fund outperformed the ETF about 86% of the time and by an average of about 11.9% per period.

However, a single index may not be the best yardstick for the fund, even if the fund’s portfolio does not undergo frequent changes. Hence, Alpholio™’s use of a custom collection of multiple ETFs as a reference for each analyzed fund.

In the simplest application of Alpholio™’s methodology, both the membership and weights of ETFs in the reference portfolio are fixed in the entire analysis period. Over the past 10 years, the fund produced about 3% of the annualized discounted cumulative RealAlpha™ vs. such a reference portfolio (to learn more about the RealAlpha™, please visit our FAQ). The top positions in that reference portfolio were the iShares Morningstar Small-Cap ETF (JKJ; fixed weight of 27.5%), iShares S&P Small-Cap 600 Value ETF (IJS; 17.6%), iShares Core S&P Small-Cap ETF (IJR; 13.0%), and iShares Morningstar Small-Cap Value ETF (JKL; 10.6%).

In a more elaborate approach, Alpholio™ uses variable weights but fixed membership of ETFs in the reference portfolio. This allows for a better tracking of the fund’s portfolio over time. Here is the chart of the resulting cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for Homestead Small-Company Stock Fund (HSCSX)

Since early 2005, the fund generated about 0.75% of regular and 1.73% of annualized discounted cumulative RealAlpha™. At 19.2%, the fund’s standard deviation was about 1% and 0.3% higher than that of the regular and lag reference ETF portfolio, respectively. The fund’s RealBeta™ was 1.1.

The fund delivered most of the cumulative RealAlpha™ beginning only after the market rebound in the second half of 2009. In 2014, the fund began to underperform its reference ETF portfolio.

The following chart shows changes of ETF weights in the reference portfolio over the same analysis period:

Reference Weights for Homestead Small-Company Stock Fund (HSCSX)

The fund had top equivalent equity positions in the iShares Core S&P Small-Cap ETF (IJR; average weight of 26.4%), Vanguard Industrials ETF (VIS; 15.4%), iShares Morningstar Small-Cap ETF (JKJ; 14.2%), iShares S&P Small-Cap 600 Value ETF (IJS; 12.5%), iShares Morningstar Small-Cap Value ETF (JKL; 12.4%). The fund clearly exhibited a small-cap value tilt.

The fixed-income equivalent position was in the iShares 1-3 Year Treasury Bond ETF (SHY; 7.7%). The Other component in the chart collectively represents four additional ETFs with smaller average weights.

An interesting aspect of the Homestead Small-Company Stock fund is that currently its top-two holdings are in ETFs (IJR and IWN). According to the article

…nearly 10% of assets now sit in small-company exchange-traded funds as a placeholder until the managers can find more compelling ideas.

This is exactly the alternative to parking assets in unproductive cash, which Alpholio™ recommended in the past. The fund should also be commended for its low turnover (average stock holding period of four to five years) and prudent distributions (i.e. a good fit for taxable accounts).

In sum, over the past ten years the Homestead Small-Company Stock Fund delivered a solid performance. However, the fund generated most of its positive cumulative RealAlpha™ only in the four-year period beginning in the second half of 2009. This year, like many of its actively-managed peers, the fund underperformed its dynamic reference ETF portfolio.

To learn more about the Homestead Small-Company Stock and other mutual funds, please register on our website.

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