Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. Print
October 29, 2001 12:00 AM

BIG IMPLICATIONS: Ennis challenges standard equity portfolio structure

Work breaks down myth of small-cap, midcap managers' consistent superiority

Joel Chernoff
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    Adapting "The Emperor's New Clothes" to money management, prominent investment consultant Richard M. Ennis says the notion that small-cap and midcap managers generate consistent superior investment performance is a myth.

    Mr. Ennis, who late last year wrote an article saying equity managers should be given broad leeway in investing their portfolios and not be tied to narrow mandates, is mounting his latest challenge to standard notions of equity portfolio structure.

    The implications for money management are substantial. As Mr. Ennis noted in an article he co-wrote with Michael D. Sebastian, director of analytical development at Ennis Knupp & Associates, Chicago, that will appear in the Journal of Portfolio Management early next year, it makes as much sense to invest passively in small-cap and midcap stocks as large-cap stocks.

    Another implication is that pension executives could use a single stock index fund, such as one tied to the Wilshire 5000 or the Russell 3000 index, that would match a fund's overall benchmark for the asset class, instead of breaking equities into smaller subcategories. A third inference is that a fund could adopt a "whole-stock portfolio" advocated by Mr. Ennis late last year, which gives managers investment freedom across a wide range of stock capitalizations and styles.

    No `fish in a barrel'

    "We're not making the case that you shouldn't be active in this asset class, but we are taking exception to the notion that it's like shooting fish in a barrel," Mr. Ennis, a principal at Ennis Knupp, said in an interview.

    The article drew varied responses from experts. "It's well-done and well-written, and kind of unassailable," said Kevin Johnson, a partner with Aronson + Partners, Philadelphia, which manages some $5 billion in various quantitative value strategies.

    Ron Kahn, managing director and head of active equities at Barclays Global Investors, San Francisco, said: "There's certainly been a myth. The myth was that it was easy to outperform in small cap. What Richard has shown is that, at least on average, it wasn't easy to outperform."

    However, Mr. Kahn added, "small-cap is actually a good place to build strategies" for skillful managers, noting that BGI's active small-cap strategy has generated excess returns of four percentage points a year for the past 11 years.

    Conclusions opposed

    Paul Greenwood, senior research analyst at Frank Russell Co., Tacoma, Wash., demurred. "Our analysis and experience doesn't support the conclusions they reached. "All of our work leads us to believe the small-cap segment of the market is the most inefficient segment of the market."

    Many pension executives and consultants believe the market for large-cap stocks is very efficiently priced, and there is relatively little value that money managers can add by actively managing such portfolios. In recent years, pension executives have directed a massive shift toward indexing or semi-indexing such portfolios, while seeking to gain alpha - or added value - from actively managed small-cap and midcap portfolios.

    Pension funds have pumped billions of dollars into active small-cap and mid-cap strategies. Universes of investment products show that small-cap managers outperform their benchmarks by substantial margins over varying periods of time.

    Now, Messrs. Ennis and Sebastian aim to prove that alpha stems from a combination of three errors: overlooking fees; using an inappropriate benchmark; and ignoring survivorship effects and other biases.

    Constructing a sample of 128 active small-cap products from the Mobius Group M-Search database, the researchers found that the median portfolio outperformed the Russell 2000 index of small-cap stocks by an average 4.04 percentage points per year over the 10 years ended June 30, 2001.

    But the vast majority of those returns were calculated before fees were subtracted. Netting out manager fees reduced the median alpha to 3.09 percentage points, still a healthy return.

    No single index

    A bigger issue is that the authors say use of a single index to benchmark returns is inappropriate, given the great degree of heterogeneity among small-cap portfolios. Instead, based on Nobel Laureate William F. Sharpe's 1992 work on style analysis, they developed for each portfolio an "effective style mix" that combines several indexes based on each portfolio's characteristics. The upshot: The median small-cap portfolio (net of fees) outperformed its new bogey by an average of 1.2 percentage points a year.

    A third issue is the effect of survivorship bias and retroactive inclusion of historical data from managers joining a given performance universe.

    The latter issue of "backfilling" is "the most insidious thing," Mr. Ennis said in the interview. Studies show how the median return has crept up for the same period of time. For example, in one universe, the median return for small-cap growth portfolios rose to 12.6% from 10.4% over a five-year period, according to Pensions & Investments' Performance Evaluation Review.

    Messrs. Ennis and Sebastian believe that survivorship bias may be greater for small-cap than large-cap portfolios. Net return inflation of two percentage points a year in databases reduces that original four percentage-point outperformance to zero or negative, they concluded.

    Rather than being easier to make money in small stocks, it might actually be tougher, they wrote. Another study the authors cited found that, in a survivorship bias-free universe of nearly 4,700 funds, large-cap portfolios achieved higher average alphas than small-cap ones from 1962 to 1998.

    Smaller-cap fees

    Why? The answer may lie in the higher fees and transaction costs charged for smaller-cap portfolios. The authors estimated typical management and trading costs for small-cap portfolios at more than 200 basis points a year, vs. 90 for large caps.

    "Whatever the differential in market inefficiency between large and small might be, it is not sufficient to justify the greater cost of researching and actively trading smaller stocks by the average manager," they wrote.

    "In every period, some active small-cap portfolio managers achieve superior results, and we do not deny the existence of (managers) with sufficient skill to add value with reasonable consistency. We find no general evidence, however, that superior performance persists from one period to the next among small-cap managers."

    Russell's Mr. Greenwood disputed Mr. Ennis' contention. He said the Russell universe of small-cap managers, measured by the real-time mean, which eliminates survivorship and other biases, shows the average manager produced an annualized alpha of about 350 basis points for the 10-year period ended June 30. Subtracting 100 basis points for management fees, that still leaves 250 basis points of outperformance, he noted.

    Recommended for You
    Read the print edition of P&I
    Read the print edition of P&I
    How low is low? Projections say it's not low enough
    How low is low? Projections say it's not low enough
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    Private Markets
    Sponsored Content: Private Markets

    Reader Poll

    August 10, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Gaining Momentum: Where Next for Trend-Following?
    The market opportunity in U.S. residential mortgage-backed securities
    Credit Indices Evolve with Enhanced Data Inputs
    Hedge Funds 2.0: Back to the future
    How Has 2022's Carnage Reshaped Global Stock and Bond Markets?
    Crossroads: Politics, Inflation, & Bonds
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    August 1, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit