Over the past five years, US equities have shown superior performance. Measured over the five years ending May 2022, the S&P 500 index achieved an annualised total return of 13.9% in euros, compared with 10.8% for the MSCI World index. The return of the MSCI Europe index compares favourably with 5.1%. Only in 2017 did US equities perform less well, but in the years thereafter it was America First.
The strong performance of the US stock market in recent years is largely due to the extraordinary performance of the so-called FAANG stocks. This group included Facebook (now Meta Platforms), Apple, Amazon.com, Netflix, and Google (now Alphabet). The rebranding of two of these companies, and the smaller market capitalisation of Netflix compared to the rest of the group, brought a new acronym to the foreground: MAMATA. This acronym also includes Tesla and Microsoft, reflecting their increasing dominance of the US market.
MAMATA accounted for 1/3 of S&P 500 return
The MAMATA group, formed by the six largest stocks in the S&P 500 - Microsoft, Apple, Meta, Alphabet, Tesla and Amazon.com - had a combined weight of 22% in the S&P 500 and 41% in the US growth index, Russell 1000 Growth, on 31 May 2022. Over the past five years, MAMATA stocks have accounted for a third of the return of the S&P 500 and half of the return of the Russell 1000 Growth Index.
The dominance of these companies has gradually increased over the years, but the coronavirus pandemic has accelerated the trend. Big technology names have clearly benefited from working from home and shopping online. Amazon.com, Apple, Microsoft, Alphabet and Meta Platforms have all benefited from the demand for e-commerce, digital advertising and cloud computing services. This, in turn, has boosted their share prices, increasing their market capitalisation and their weight in US indices. Tesla was not added to the S&P 500 until December 2020, but its market value has skyrocketed in recent years, with a cumulative return of 1067% in euros over the last five years through May 2022.
While MAMATA stocks have pushed the US stock market to great heights, it turns out that they are not immune to gravity either. Rising inflation and higher interest rates put pressure on growth stocks. Loss-making technology companies in particular could no longer appeal to investors and went on sale, while the old industry, led by energy companies, was rediscovered. The correction for the so-called long duration stocks was severe, with price drops of 10-20% for the renowned growth leaders, with Meta faring worst, with a 40% fall through May. Meta’s fall, reduced market capitalisation and revaluation mean that, according to research house Jefferies, it will receive a 1.8% index weighting when index compiler Russell revises its indices in June. However, it will not be weighted in the Russell 1000 Growth index, but in the Russell 1000 Value index. The weighting in the growth index is expected to be considerably lower, at around 0.5%.
Risk-adjusted returns
The large shifts in relative performance between companies and sectors in the US equity universe show how erratic the market can be from time to time. This variety in returns is sometimes underestimated by investors. Investors are focused on returns, but the risk of realising these returns is at least as important. Performance should therefore not be measured on the basis of total return, but on the basis of risk-adjusted returns. The Sharpe ratio combines return and risk, measured by standard deviation. This ratio is calculated by subtracting the risk-free rate of return of an investment fund and dividing it by the standard deviation. The resulting number indicates the return achieved per unit of risk. The higher this number, the better the risk/return ratio.
The universe of funds considered for this week’s top five consists of all funds, both active and passive, that are part of Morningstar’s US equity categories, namely large-cap value, large-cap mixed, large-cap growth, flex-cap, mid-cap, small-cap and dividend.
Brown Advisory US Sustainable Growth
The funds were then ranked on their Sharpe ratio over the past five years as at the end of May 2022. Out of more than 2,000 mutual funds, Brown Advisory US Sustainable Growth achieved the best risk-adjusted return with a Sharpe ratio of 0.89.
The impressive track record of the fund, which is rated Silver by Morningstar analysts, is the result of an effective combination of ESG integration and fundamental bottom-up stock selection. Karina Funk and David Powell have led this strategy for more than a decade. Funk, who is based in Boston, has been with Brown Advisory since 2007 and brings the necessary ESG expertise. In her 17 years in the industry, she has held many investment positions involving ESG analysis. Powell, working out of Baltimore, is an industry and firm veteran. He has spent more than two decades at Brown Advisory. The duo works closely with the more than 25 equity analysts who make up the central analyst team. While most analysts have sector-specific focus areas, a number are also generalists. Funk and Powell work particularly closely with the group’s sustainability analysts. These analysts work with the fundamental analysts to assess ESG risks and competitive advantages.
The managers look for companies with ESG-driven competitive advantages that ultimately lead to cost reductions, higher revenues or improved franchise values. Potential and current holdings also undergo a thorough ESG risk assessment and upside/downside scenario analyses. The managers’ emphasis on sustainable competitive advantage has resulted in a low portfolio turnover rate, typically around 20% per year. The concentrated portfolio of 30 to 40 stocks is differentiated.
Funk and Powell typically invest in smaller companies than the Russell 1000 Growth Index and have steered clear of many behemoths in the benchmark, such as Apple and Meta Platforms. Instead, they have found more opportunities in the healthcare sector, which accounted for about 24% of the portfolio in April 2022 versus 9% of the benchmark.
IShares MSCI USA SRI ETF
In second place, we also find a fund with a sustainable bias, namely the IShares MSCI USA SRI ETF. The strategy is designed to exclude underperformers on various environmental, social and governance issues, such as carbon emissions and controversial weapons, while also using a best-in-class ESG selection approach to build a diversified portfolio.
This strategy draws on the research of the MSCI ESG Research team, which uses a range of in-house systems to create a best-in-class ESG stock selection process. The selection is based on exclusion and targets the top 25% of free float adjusted market capitalisation in the MSCI USA universe, based on various ESG indicators such as (but not limited to) ESG risk management, controversies and climate change data. In addition to a 5% cap on the weighting of individual stocks to ensure adequate diversification, the strategy also includes a screening for companies active in fossil fuels, an exclusion that is not part of the standard MSCI ESG Business Involvement Screening.
Top 5 as per Netherlands fund classification:
Top 5 as per Belgian fund classification:
This article was originally published on InvestmentOfficer.nl.