What’s Bubbling Up? The Hidden Costs of Indexing
Investors eager for “safety” have been piling into indexed portfolios at the expense of actively managed strategies—and thus making a big, and risky, bet against deep value and for high-dividend yielding stocks. We think they’re pursuing just the wrong course.
We see significant opportunity for outsize returns in deep-value stocks and an unusually high degree of downside risk in the high-dividend payers.
You can see the opportunity by comparing the weight of the two groups within the S&P 500. Outperformance by stocks paying high dividends has driven their index weight to a record high: almost 45% of the index’s market capitalization is in stocks with a dividend yield 20% or more higher than the index, as the display below shows. At the same time, underperformance has driven down the weight of low-price-to-book stocks. Roughly 25% of the S&P 500’s market cap lies in stocks with a price/book ratio 20% or more below the market P/B. That’s even less than during the tech bubble!
Since 1970, the median market cap of the two groups has been similar: 34% for high-dividend payers, and 31% for the low-price-to-book group. If the mix normalizes—as it has historically—low-price-to-book stocks will outperform and high-dividend payers will underperform. Investors in the index could be slammed two ways.
Deep-value stocks have outperformed the market significantly over time, with large bursts in outperformance following prior periods when poor performance drove down their market weight. In the 12 months after earlier low points in their index weight, low-price-to-book stocks have outperformed the market handsomely: by 3.8 percentage points in the 12 months after August 1978, by 12.7 points after October 1990, by 7.5 points after December 2000, and by 10.3 points after November 2008. And indeed, the gap in market weights between low-price-to-book and high-dividend yield stocks wasn’t as wide at those points as it is today.
If we assume a relatively conservative 10% future outperformance by low-price/book and 10% underperformance by high-dividend paying stocks, index investors may be leaving almost 200 basis points annually on the table, owing to the biased construction of the S&P 500 today.
And we estimate that a portfolio with exposures to high-yield and deep-value stocks close to the historical average could outperform the S&P 500 by as much as 15%.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Vadim Zlotnikov is Chief Market Strategist for AllianceBernstein.