For both Fundamental and Quantitative investors, hardly a month goes by without an update to the great Value debate. The latest shot across the bow comes from a paper published by Sparkline Capital in which they theorize that the demise of the Value factor is due to the underestimation of the effects of technology disruption in traditional capital markets. Sparkline Capital breaks out the FAAANM stocks (Facebook, Apple, Alphabet, Amazon, Netflix and Microsoft) from the rest of the S&P 500 to analyze FAAANM sector performance along with the remaining S&P 500 ex-FAAANM stocks. They leverage machine learning technologies to expand the analysis and create a “Tech Disruption Factor” that is agnostic of sectors, which performs strongly and carries a negative exposure to Value.
In this issue of Factor Spotlight, we’ve run our own variation of the analysis on the FAAANM and ex-FAAANM portfolios and apply a commercially available factor risk model on these portfolios using the Omega Point platform. We humbly don’t enter the Value debate fray, but attempt to shine a different lens on it.
Portfolio Construction and Initial Analysis
To build the FAAANM model we simply take Facebook, Apple, Amazon, Alphabet, Netflix, and Microsoft and cap weight them on a monthly basis. To build the S&P500 ex-FAAANM we remove these names from the S&P500 and re-normalize the remaining names back to 100%.
We also highlight below the last decade’s worth of Value’s factor returns. We see it has been a mixed bag with some ups and downs, ending down -4.86% despite some recent attempts to rally back up. While this chart isn’t as long-term as French’s, we still see the doldrums in this factor’s performance.
We also observe the cumulative active performance of FAANM and S&P500 ex-FAANM over the S&P 500 benchmark over the past decade.
FAAANM stocks over the last decade make up all of the S&P 500’s returns and more than compensate for the S&P 500’s losers.
Below is the total predicted risk of these two portfolios:
A Deeper Dive into Risk
To better understand the drivers of these risks, we take the FAAANM portfolio and measure it relative to the S&P500 ex-FAAANM. Below are the high level risk drivers over this time period, where we see two major shifts in risk trends:
Towards the end of October 2013, we see that Specific risk starts to become less and less of a risk driver, and Sector risk starts increasing relatively dramatically from where it started. In May 2019, we see the Sector risks start to drop off, Specific risks pausing before dropping during the COVID crisis, and Style risks really taking off and driving the active risk in these two portfolios.
We see that over 20% of the active risk is coming from Medium-Term Momentum alone! While Medium Term Momentum has on average performed positively over time, it’s also a factor that “goes up on the escalator and down on the elevator”, suggesting potential downside risk in the FAAANM portfolio if Medium-Term Momentum were to ride the elevator to the basement.
Profitability Exposure - Trailing 10 Years
We see that over this time period the FAAANM portfolio has had a much higher exposure to both Growth and Profitability, although this has steadily been decreasing. The question is, will the markets still be interested in paying a premium for FAAANM stocks with degrading fundamental characteristics? If this does happen, will the FAAANM stocks drag Medium-Term Momentum down with them? Or is the tech disruption from these names only the beginning and the world needs a new definition of “Value” where disruption potential is taken into account? The jury is still out with the final verdict still pending, and bets being made on both sides. Regardless of your positioning, being factor aware in your portfolio construction and risk management is as important as ever.
US & Global Market Summary
US Market: 8/10/20 - 8/14/20
Please let me know if you’d like to continue to discussion around Value and Big Tech, or would like to better understand your portfolio’s relationship to any of these factors.