So AEIQ is taking fliers on tiny companies and riding the wave in small caps to beat the S&P, right? But it outdoes small-cap indexes, too. Since inception, the ETF is beating the Russell 2000 with noticeable help from the “selection effect,’’ meaning picking particularly good securities, Bloomberg data show. AIEQ’s active return over the small-cap gauge is 6.03 percent, all of which can be explained by individual stock
To true believers, nothing random is happening. “It’s not serendipity or luck. Rather, it is grunt work analysis of computational analysis of data and looking at your blogs and social media and press releases, and a conglomerate of all that,’’ Rick Roche, managing director at Little Harbor
Advisors, a boutique investment firm focused on quantitative strategies, said in an interview at Bloomberg’s New York headquarters. “Machine learning’s power in terms of getting data and uncovering potential alpha is much better in the small cap and the mid cap space than it is large cap.”
It’s easy to be impressed by the way AIEQ’s seems to adapt over time, adding large caps to its portfolio and dialing down smaller companies right as they fell out of favor. In truth, though, other things may be going on. Sure, the machine might’ve sussed out an unwinding of the small-cap trade in the wake of rising rates and less trade bluster. Less amazingly, the ETF may have just needed to buy larger stocks as it got bigger and swelled toward $200 million.
Either way, it helped. Since the start of August, AIEQ’s greater allocation to larger companies has juiced its performance, a Bloomberg analysis shows. “That’s the benefit of our strategy, right? It is very flexible and dynamic,’’ said Art Amador, COO and co-founder of Equbot, the company behind the ETF’s software. “The idea of, ‘Hey, it’s small caps today,’ doesn’t mean tomorrow we’re going to keep playing in the small-cap universe. In fact, it’s quite the opposite.’’
When you buy an ETF you are buying all the shares in the index with a market cap bias. Logically some will do better than others but there is an implied momentum trade because of the focus on the best performing the large companies.
If a computer is programmed to invest simply based on momentum rather than market cap weighting then it has the capacity to outperform. This is a twist on the fact that equal weighted portfolios tend to outperform over time. I suspect that goes farther in explaining the performance of so-called robo traders than price discovery from twitter feeds etc.
This total return comparison chart highlights the fact that the robo ETF tends to fall more during times for stress when correlations tighten, so investors would should be wary of bold claims that some magic formula has been discovered.