Asset Allocation Chart of the Month
Where Quality Helps the Most
- We created a quantitative quality model to test whether focusing on quality metrics can improve performance in the small and mid-cap space. We backtested the model using Bloomberg’s equity screening tool.
- Our universe was the Russell 2500 Index, which includes small and mid-cap stocks. We screened for stocks with the following characteristics:
- Positive earnings over the past 12 months
- Net debt-to-EBITDA ratio below 4x
- Return on equity (ROE) above 10%
- Our chart shows performance from a backtest that equal-weighted the stocks passing our screen, an approach we think better reflects how an active manager might allocate across a small or mid cap portfolio. However, we note that the results were similar to a market cap-weighted version: the market-weighted version returned 10.9% annualized.
- We also included results for the S&P 1000 Index, another small and mid-cap benchmark that already excludes companies with negative earnings. This let us isolate the added value of our other two quality metrics: balance sheet strength and profitability.
- For simplicity and to reduce turnover, we rebalanced annually, which is also how Bloomberg reports returns. This limits our ability to analyze volatility using higher-frequency data, but the results still support the idea that quality can provide downside protection.
- Over the last 25 years, the Russell 2500 Index had 6 down years. The model outperformed in five of them, with the only exception being slight underperformance in 2015. Of the 19 up years, the model outperformed in 11, and even when isolating only the up years, the model outperformed the indexes.
- We ran the model in the large cap space and found it to be less impactful. Having a quality bias clearly helped in down years, but the model underperformed in up markets. We also found that the weighting methodology in large caps mattered: in the first half of our 25-year test period, through the Great Financial Crisis, an equal-weighted approach added value. Since then, market weighting had been more effective.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA - Vice President and Senior Fixed Income Strategist, and Brian Cheyne, CFA, CIMA - Senior Investment Strategy Specialist, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800-638-8194 for more information.
A Word About Risk
Fixed-income securities can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/ or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities may be downgraded by a Nationally Recognized Statistical Rating Organization to below investment grade status. Non-investment grade debt securities are considered speculative with respect to the issuers' ability to make timely payments of interest and principal, may lack liquidity and has had more frequent and larger price changes than other debt securities. Equities are subject to market volatility and loss. Growth stocks may be more volatile than investing in other stocks and may underperform when value investing is in favor. Value stocks may not appreciate in value as anticipated or may experience a decline in value. Stocks of large-cap companies may be unable to respond quickly to new competitive challenges. Stocks of small- and mid-cap companies may be subject to more erratic market movements than stocks of larger, more established companies. Investments in foreign, and emerging market securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. The risks associated with investing in foreign markets are magnified in emerging markets, due to their smaller and less developed economies.
The information provided reflects the research and opinion of Touchstone Investments as of the date indicated, and is subject to change without prior notice. Past performance is not indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing in certain sectors may involve additional risks and may not be appropriate for all investors. The indexes mentioned are unmanaged statistical composites of stock or bond market performance. Investing in an index is not possible. For Index Definitions see: TouchstoneInvestments.com/insights/investment-terms-and-index-definitions
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
Investment return and principal value of an investment in a Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. All investing involves risk.
Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.
Touchstone is a member of Western & Southern Financial Group
Not FDIC Insured | No Bank Guarantee | May Lose Value
