Articles by Scott Opsal, CFA Chief Investment Officer

Real Estate was the top performing sector in the final quarter of 2023, climbing an impressive 18.8% against the market’s 11.7% gain.  Signs of enthusiasm for the REIT industry have been rare in recent times.  While the S&P 500 gained 96% over the last five years, REITs returned a paltry 31% over that time.  We wondered if last quarter’s success signaled that it was time to take a fresh look at the group.  This report examines the investment merits of REITs as an asset class, using the mental model of evaluating “what you pay vs. what you get.”

While mid- and small caps notably underperformed, large growth results were freakish. Measured against the S&P 500 Growth index, an implausible 96% of active large growth funds beat that benchmark—a result that stands as one of the most extreme win rates ever seen for a style box.

Since the pandemic, investors have been leery of adding REITs to their asset mix due to fears that flexible scheduling and work-from-home will permanently diminish the demand for office space. While that view may prove correct, the magnitude of such a change is much less significant than some might suspect.

The Magnificent Seven’s remarkable performance defines the stock market in 2023. This basket of the seven largest companies in the S&P 500 index gained an average of 111% vs. an average gain of 9% for the other 493 companies. The combined impact of huge index weights and outsized performance made 2023 one of the most top-heavy markets in history. Whenever assets outperform to this degree over just a few quarters, the valuation alarm bells start clanging. Could the fundamentals possibly justify such a massive advance, or is AI mania responsible for the outperformance?

Speculating on the link between style performance and interest rates is a favorite pastime of factor aficionados, but 2023 provided a real-time laboratory to evaluate those ideas. We examined factor returns during the interest rate swings to uncover some empirical insights into this important relationship.

Whenever a basket of stocks with the market heft of the Magnificent 7 shows a price gain of 111% in a single year, the valuation alarm-bells ring loud. Is this gain the result of a mania for all things AI, or could the move be justified by equally magnificent fundamentals? 

Depending on how you measure it, with a few days to go, it’s either been a superbly profitable 2023 or a year that barely crept above the 30-year average.

This month’s Refresh continues our practice of summarizing the latest earnings season by evaluating the composite results of the S&P 500 member companies.

Will 2023 be remembered as a delightful year with +20% returns, or might it go down as a time when stocks lagged even a risk-free money market fund? We introduce this month’s research topic: The huge return disparity between the capitalization weighted S&P 500 and the equal weighted version.

Performance chasing is one of the most common behavioral errors made by mutual fund investors and represents one of the most heavily traveled roads to poor investment results.  Now, when we use the phrase performance chasing it is universally understood that we are talking about chasing good performance. That is why we are so intrigued with TLT, this year’s fund flow leader among bond ETFs. The iShares 20+ Year Treasury Bond ETF has raked in over $20 billion in new assets this year, but not by posting strong results. Rather, inflows have surged despite returns that are frankly terrible. Such an incongruity deserves a closer look, and this study lays out some of the key storylines behind this surprising development. 

One of this year’s most fascinating stories in financial markets evolves around investors’ atypical response to the dreadful returns posted by TLT (iShares 20+ year Treasury bond ETF). Despite its dismal performance, investors have been moving a tremendous amount of money into TLT. 

Our analysis has consistently affirmed that actively managed portfolios do relatively better against their benchmarks during weaker market settings. In terms of active vs. passive, portfolio managers should love bearish environments, and third-quarter returns held true to that notion.

The momentum style factor has a long history of producing excess returns and is found in the security selection toolbox of many asset managers. This concept is regarded with such esteem that a number of ETFs have been launched to capture this value-added factor, including eight funds with AUM exceeding $300 million. The Magnificent Seven, the seven largest stocks in the S&P 500 index, have booked remarkable returns in 2023 with the equal weighted performance of this basket of tech titans gaining 88% YTD. The also-rans that make up the other 493 members of the S&P 500 have collectively returned a pathetic 1.6%. The Magnificent Seven seem to embody the momentum factor perfectly, yet momentum ETFs have been hugely disappointing this year. Not only have they failed to capture the Magnificent Seven move, but these ETFs have also badly lagged the broader market. This leads to the question, “In a seemingly perfect environment for momentum, what happened to the missing mo?”

The dominating and overwhelming gains by the Magnificent Seven have made it nearly impossible for most traditional equity factors to excel. Only two styles have managed to surpass the S&P 500’s YTD return: Growth and Quality—and both have healthy exposures to the Magnificent Seven.

In a year when the Magnificent Seven has epitomized the concept of price momentum, investors who spotted that phenomenon and employed a momentum ETF to capitalize on the trend were not rewarded: Owning MTUM or SPMO not only forewent the tech titan rally, they both badly lagged the S&P 500.

If uncertainty is the bane of investors everywhere, then the fear of large losses in a bear market is the boogeyman hiding in the closet. The threat of an agonizing downturn often leads investors to carry lower equity weights in their balanced portfolios than might be advisable, and even drives them to hold excess cash to avoid the risk of sizable declines.

ETF families have responded to this anxiety with a fund design that takes some downside risk off the table and may enable investors to tiptoe into equities even when they suspect a selloff might be around the corner. Known as “buffer”, “defined outcome”, or “target outcome” funds, these ETFs utilize an options collar overlay to trim the upside and downside tails of the underlying asset’s return distribution, thereby giving nervous investors a more comfortable way to pick up some equity exposure during riskier times.

This month’s Refresh continues our practice of summarizing the latest earnings season by evaluating the composite results of the S&P 500 member companies. Many analysts address sales and net income, but rarely speak to the middle lines of the income statement.

Option collar strategies provide a defined outcome on the date of maturity, but the value from inception to maturity varies. In the case of an extreme market move either direction, a collar strategy will not capture the fullness of the fluctuation early in its lifecycle, but should reach its cap/floor value as maturity nears.

Despite skyrocketing investor enthusiasm, buy-write strategies are complicated investments with skewed payoff structures that muddle the interpretation of past performance, because returns depend on market conditions.

The active/passive performance derby experienced a severe case of whiplash the last three months. Through the end of the first quarter, market conditions were advantageous for active managers, now the second quarter has revealed a massive shift in favor of passive styles.