Journal of Indexes, 2006 - IndexUniverse.com

Tactical investors who use style rotation strategies now
have a new, genuinely innovative investment tool—
the S&P/Citigroup Pure Style Indices. Unlike most
other style indexes, which weight stocks based on market
capitalization, the new Pure Style indexes are weighted by
their growth and value exposures. This gives investors more
of a pure play when making style allocation decisions—in
essence, helping them keep their style bets more completely
focused “inside the box.”
This article briefly describes the methodology, advantages,
disadvantages and applications of the Pure Style indexes, and
compares them with their more comprehensive but less
focused sister indexes, the S&P/Citigroup Style Indices.
New Sco ring and We i g hting Me t h od o l og i e s
In May of 2005, Standard and Poor’s (S&P) announced
plans to retire its S&P/BARRA style index family and replace it
with two new sets of indexes: the S&P/Citigroup Style Indices
(“Style”) and S&P/Citigroup Pure Style Indices (“Pure Style”).
As with the old S&P/BARRA style benchmarks, the new Pure
Style and Style index families feature six indexes each, broken
down into the traditional size (large, mid- and small cap) and
style (growth and value) categories. 1
The new indexes use an objective scoring methodology
that incorporates seven common factors characteristic of
either growth or value stocks (Figure 1). This is in sharp contrast
to the old indexes, which defined growth and value
based on a single factor: the book-to-price ratio.
Beyond the more nuanced style scoring methodology, the
new indexes also differ from the old S&P/BARRA indexes by
implicitly acknowledging that growth and value characteristics
are not mutually exclusive. To do this, the indexes determine
the growth and value scores for individual components
separately. For each stock in the parent index (e.g., the S&P
500), the new methodology calculates a growth score by averaging
three standardized growth factors, and separately calculates
a value score by averaging four standardized value factors.
It then assigns stocks with the highest relative growth
ranks to a “Pure Growth” basket, stocks with the highest relative
value ranks to a “Pure Value” basket and stocks in
between to a “Core” basket.
The Style indexes are then assembled using traditional
capitalization weighting. S&P constructs the Growth index by
including all of the stocks in the Pure Growth basket at 100
Figure 1
Growth Factors
Five-year historic
earnings/share growth
Five-year historic
sales/share growth
Five-year average
internal growth rate*
www.indexuniverse.com/JOI
Standardized Factors Used In
Style And Pure Style Indexes
* Internal Growth Rate=Return
on Equity (ROE) X (1-Payout Ratio)
Value Factors
Book-to-price
Cash flow-to-price
Sales-to-price
Dividend Yield
Source: Standard and Poor’s, S&P U.S. Style Indices: Teleconference
Presentation, September 20, 2005.
percent of their capitalization, plus all of the stocks in the
Core basket at the fraction of their market capitalization that
represents growth. The Value index is constructed in a similar
fashion.
In contrast, the Pure Style indexes are built using style
weighting. S&P generates the Pure Growth index by including
all of the stocks in the Pure Growth basket that have a minimum
growth score, and then weights these stocks by their
growth score. The Pure Value index is created in a similar
fashion. Core stocks are excluded. 2
The major differences between the two sets of indexes can
be summarized as follows:
• Universe coverage: The Style indexes include all stocks
from the parent index. By contrast, the Pure Style indexes
include only stocks from the Pure Growth and Pure
Value Baskets.
• Overlapping stocks: While some stocks tracked by the
Style indexes appear in both the growth and value style
categories, the Pure Style benchmarks do not overlap—
stocks are either identified as Pure Growth or Pure
Value.
• Weighting scheme: The Style indexes are weighted by
market cap, while the Pure Style indexes are weighted by
style scoring.
• Breadth: The Style indexes offer broad coverage of the
market, while the Pure Style indexes are narrower and
more focused.
Adva ntages Of The Pu re Style Indexe s
Because the Pure Style indexes omit stocks in the Core basket,
and because the stocks they include are weighted by
their growth and value scores, we believe the Pure Style
indexes are superior to the Style indexes for use in style rotation
strategies. This is primarily attributable to the superior
contrast that exists between growth and value. For example,
the average monthly return spread is in the 4 percent range
for the S&P/Citigroup 500 Pure Style Indices, compared to the
2 percent range for the S&P/Citigroup 500 Style Indices. The
Pure Style spreads are consistently larger than the Style
spreads for mid- and small-caps as well.
There is also a far lower correlation between growth and
value within the Pure Style indexes compared to the Style
indexes. This is true for large, mid- and small caps. For tactical
asset allocators, this contrast should help magnify the
impact of making the “right” decisions based on shifting style
movements.
Finally, performance for the Pure Style benchmarks has
been demonstrably better. Over the ten years ending
December 31, 2005, the S&P/Citigroup 500 Pure Growth
Index outperformed the S&P/Citigroup 500 Growth Index by
4.07 percent per year. Similarly, the S&P/Citigroup 500 Pure
Value Index outperformed the S&P/Citigroup 500 Value Index
by 4.05 percent per year. In the mid- and small-cap arena, the
Pure Style indexes outperformed the Style indexes by 1.73
percent to 2.17 percent, except for the S&P/Citigroup 400
Pure Growth Index, which underperformed the S&P/Citigroup
400 Growth Index by 0.70 percent. 3
September/October 2006
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