Tuesday, February 28, 2006

Outperformance Blues

As highlighted in my Jan 7th 2006 post on "ETF's & the Liabiity of Cap", many participants had just finished pursuing the cynically easy trade of buying smaller cap and selling index exposure. I posited that this depressed large and mega-cap returns (not just in Japan I would point out) and generated large performance fees for those fortunate enough to be sitting in the catbird's seat, possessing sufficient firepower to be the largest marginal buyer of some stocks for a few months. I suggested this would of course unwind in due time.

Checking back it is noteworthy that this "trade" is beginning to unravel (again, not just in Japan, but all the USA). This is perhaps best exemplified (for those interested in arcane but descriptive facts), that we are now witnessing a five-year low in the number of stocks that are outperforming the TOPIX index (on a rolling basis)over the previous 12 months. This number now stands at 40%. It has been falling for all of 2005, retreating from the very positive levels (approx mid 60's%) resulting from the pricking of the TMT bubble followed by the meaningful broadening of gaijin portfolios from their narrow "under-weight Japan" focus.

Now continued outperformance by high-momentum, coupled with a reversal of large-cap underperformance, has led to a brisk acceleration making it extremely difficult to "beat the index" without owning cap and high-momentum, which itself is risky if only because the high momentum securities are...well...so high and relatively poorer value than virtually anything else one might conjure the thought of adding to one's portfolio. It potentially has some more to run, but this seems likely to come - not from the outperformance of the positively skewed momentum portion, but rather from the largest and most neglected of the large caps that have been the whipping boys of many a hedge fund short portfolio.

Good things come to those who wait.

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