Microcap Trending Value is an investing strategy that selects for investment the microcap stocks with the highest momentum among the cheapest stocks in the universe. The strategy is inspired by Jim O’Shaunessy’s strategy highlighted in What Works in Wall Street. Our implementation has generated returns of over 19% per year on average, with relatively low volatility, and low asset turnover.
I have rigorously tested my screener and strategy using the best-known methods to avoid curve-fitting and cognitive biases. Let’s see how it fared in the short-term (i.e., in 2019) and the long-term.
Our implementation of the Microcap Trending Value strategy is implemented as follows:
- We start with a universe of all the stocks trading in NYSE with a market cap above the 20th percentile (about $30M) and up to the 40th percentile (about $200M)
- Liquidity – We eliminate stocks with less than $5K traded daily on average
- We filter stocks based on Valuation – we keep the cheapest 10% of stocks based on a Composite of Value Multiples (P/E, P/B, P/Sales, EV/EBITDA, P/FCF, Shareholder’s Yield)
- We filter stocks based on Quarterly and Bi-Quarterly Momentum – We keep stocks that delivered higher returns than the Russel 2000 during the last Quarter and Half-Year and eliminate the rest.
- We sort stocks based on Yearly Momentum – the higher the 52w returns, the higher the rank
Microcap Trending Value (MTV) Screener Performance During 2019
The following chart presents the performance of a quantitatively-selected portfolio of 25 stocks, The smallest stock in the sample is Acme United Corp (ACU) with a $78M market cap and the largest stock is SmartFinancial Inc (SMBK) with $323M market cap.
All stocks were bought on January 1st, 2019, and held for exactly one year.
Unfortunately, Microcap Trending Value did not beat the market during 2019. It has returned 8.2% per year, on average, vs. the Russell 2000s 25.39%, including dividends. Ouch.
Does it mean that Microcap Trending Value has lost its charm and is no longer a good investment strategy?
2019 was not a good year for Value and Momentum investors, especially in microcaps, regardless of their style and specific methodology.
Long-Term Performance of Microcap Trending Value
The following chart presents the performance of my version of the MTV portfolio over a 5-years period, May 31st, 2014, to June 30th, 2019. The reason I do all my long term backtests starting June 30th is two-fold: 1) to be consistent with academic research who uses such convention 2) to be consistent across all my publications, enable readers to compare all my backtests, apples to apples. I start the portfolio in May rather than in June due to the calendarization effect (see discussion in Quantitative Momentum).
We can see that the performance over a 5-years period was better than Russell 2000’s performance. The MTV model was ahead of the benchmark for the larger part of the 5-years period. It yielded 8.69% average annual returns vs. Russell 2000 with 7.9%, including dividends.
Testing the strategy over 20 years starting May 31st, 1999, and ending on June 30th, 2019:
Microcap Trending Value delivered astonishing average annual returns of 18.64% vs. 7.9% for the Russell 2000. Over the long term, MTV beats the benchmark (and any other strategy I am familiar with) heads over feet. Moreover, it has done so with lower volatility, as measured by the standard deviation of monthly returns. The standard deviation of the strategy came in 17.08% vs. 19.44% for the Russell 2000, as can be seen in the following table. Sharpe ratio is at a super high level of 0.98x vs. 0.38x for the Russell 2000. The correlation with the Russell 2000 benchmark is a mere 64%. It means that only 64% of the months tested, the Russell 2000 and the model both appreciated or both declined. In all other cases, when the market declined during a month, the model appreciated, and vice versa. Over the long term, MTV develops a healthy margin over the market and runs much higher.
The strategy overperformed during the last 20 years and also during the last 3 years, unlike several other Value Investing strategies.
Looking at the yearly performance in the following table, we see that in most of the years during the last 20 years, the MTV model delivers positive excess returns over the market. It had underperformed the benchmark in only 6 of the last 20 years.