Peter's Perspective
8th June 2016 by Tama Churchouse

Beating the S&P 500… Revisited

In November of 2014 we wrote a short Peter’s Perspective called “Outperformance & Lower Risk”.

The premise was simple: could we find an easy way for anyone to outperform the S&P 500?

Back then, there were roughly US$5.14 trillion dollars benchmarked against this equity index.

Today that number has risen to an incredible US$7.8 trillion dollars… that’s the equivalent of nearly 45% of total U.S. gross domestic product.

Of that US$7.8 trillion, roughly US$5.6 trillion is actively* benchmarked against the index.

*Active managers work on beating a particular benchmark index. Passive managers, or tracker funds on the other hand simply seek to replicate the index as closely as possible.

In other words, investors (individuals, pension funds and everyone in between) have US$5.6 trillion parked with investment managers who are actively trying to beat this index.

There’s a lot at stake!

We suggested a simple strategy: split your broad U.S. equity allocation equally between two simple ETFs.

The first ETF we suggested was the Guggenheim S&P 500 Equal Weight ETF (RSP US).

The rationale here was simple: the S&P 500 is a market-cap weighted index. This means the bigger the company, the bigger its weight in the index.

Larger companies in this index are typically great companies, but they’re more mature and are perhaps prone to more modest growth.

Right now for example, Apple, Microsoft, Exxon, Johnson & Johnson and General Electric constitute over 10% of the S&P 500. That’s just five companies out of 500!

We showed some historical analysis of equal-weighting versus market-cap weighting and we found outperformance in the bull markets… but less protection in the bear markets which makes sense.

The J&J’s of the world have long survived multiple cycles, yet smaller firms with a lower weighting in the S&P 500 might not fare so well.

So, we looked to balance our equal-weighted equity allocation with a lower volatility ETF.

We selected the PowerShares S&P 500 Low Volatility Portfolio (SPLV US).

This ETF simply picks the 100 least volatile stocks from the S&P 500 universe. It measures the prior one year of volatility for each stock and picks the 100 lowest.

As a result, it’s more geared towards defensive sectors like REITs and utilities for example.

How is our basket performing so far?

On a total return basis, the S&P 500 ETF (SPY US) has returned 5.67% since the 21st of November 2014.

Our basket of equal-weight and low volatility ETFshas given a 9.30% total return… that’s 3.63% of outperformance.

That may not sound like much, but 3.63% as a proportion of 5.67% is significant in a little over 18 months.

Most fund managers would take that in a heartbeat!

Importantly, we’ve also done this with less volatility (14.5% vs 15.3% for the S&P 500 ETF).

The million-dollar question… or should I say, the 5.6 trillion-dollar question… is will our simple ETF basket continue to outperform, with lower volatility?

All I can say is, so far so good…

Good investing,


P.S. In the latest edition of The Churchouse Letter (“Diving Into Dividends“) we recommend two specific dividend ETFs… we sound a warning on a large dividend-focused ETF that might be in your portfolio already… and we revisit one of our all-time favourite Asian dividend blue-chips.

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