Getting to the Core of Stock Market Behavior: An Undiscovered Treasure in Defensive Diversification

Some index providers include these stocks in both value and growth on a pro-rata basis – a fraction of the stock is assigned to value with the balance assigned to growth. By contrast, Surz Style Pure® indexes track and maintain a separate category called Centric Core, not to be confused with “blend core,” the more common usage of the word “core.”


For clarification, the S&P 500 has been used extensively as a core portfolio in core-satellite investing. The S&P is a blend core because it encompasses both value and growth stocks, as well as the stuff in the middle I call Centric.


Centric Core is a better diversification partner for active money portfolios because it does not dilute the active managers and it behaves differently than value and growth, so it smooths out the performance ride – the role of a diversification complement. It also adds an important insight to our understanding of stock market behavior.


In 2008, Centric Core’s 29% loss outperformed growth by 1,600 basis point and value by 300 basis points. This is important because most managed money programs are making an unintended bet against Centric Core by allocating to the four corners of the style matrix – large value, large growth, small value and small growth.


But Centric doesn’t always win. In this past month Centric Core’s 7% return lagged value by 500 basis points and growth by 400 basis points.


A close examination of relative performance is revealing. As shown in the chart below, Centric Core tends to perform better than value and growth in lower-performing markets and worse in high-performance markets. And Centric is outside the middle, between value and growth, about half the time. In other words, Centric surprises about half the time by not performing in between value and growth, in much the same way mid-cap companies surprise by not performing in between large and small.

So what can be made of this relative performance? I have one interpretation and would certainly welcome others.


The active management world is comprised of value and growth managers. Even the managers who call themselves “core” are a blend of value and growth rather than the Centric Core version examined here. Active manager trading impacts market prices. When they are buying, stocks go up. When they are selling, stocks go down. In this interpretation, the relative behavior of Centric Core is a reflection of professional investment management sentiment. As a consequence, Centric Core is a diversification complement that performs well in distressed markets but sacrifices in ebullient times.


In other words, Centric Core is a defensive play that rounds out most multi-manager portfolios. Centric Core deserves your consideration, and can be easily incorporated because it is only 45 stocks, all of which are large companies.

 

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