As concerns over inflation, the Federal Reserve aggressively raising rates, and sluggish economic growth led the S&P 500 to post its worst first-half performance since 1970, small-cap funds didn’t do so bad during the first half of 2022. According to Anu Ganti, senior director, index investment strategy at S&P Dow Jones Indices, the comeback of smaller-caps might have positive implications for active managers.
“Mega caps were hit particularly hard, with the S&P 500 Top 50 posting a loss of 22%, underperforming the S&P 500 by 2%,” Ganti wrote in the S&P Dow Jones Indices Indexology Blog.
But this weakness among mega-caps was a tailwind for the S&P 500 Equal Weight Index due to its bias towards small-cap stocks, with the Equal Weight Index outperforming the S&P 500 by 3% so far this year. Ganti noted that the Equal Weight Index being underweight to IT and communication services was a key contributor to its outperformance.
The outperformance of small-caps and equal weight could bode well for active managers, as their portfolios are often closer to equal- than cap-weighted. In plotting the underperformance of large-cap funds compared to the relative performance of equal weight versus the S&P 500, as a proxy measure for smaller-cap outperformance, Ganti wrote that two out of the three years when most active large-cap managers outperformed (2005, 2007, and 2009) coincided with equal weight’s outperformance.
This analysis syncs up with the recent observations from Morningstar’s chief ratings officer Jeffrey Ptak, who wrote on Twitter that active small-cap U.S. equities funds did better than large-cap in the first half of 2022.
“The relative performance for active small-cap managers in the first half is impressive given the market volatility. Managers were able to find hidden gems and demonstrate a value add in a challenging environment,” said Todd Rosenbluth, head of research at VettaFi.
With inflation the highest it’s been in four decades and interest rates rising, markets are expected to remain volatile. In such a volatile market, passive ETFs may not offer protection against downside risk. They also don’t offer investors a way to seek above-average returns.
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