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Keeping Your Money Inside The Box
Purifying your approach to style investing
by Paul Lenz, Ph.D., and Michael Dellapa, CFA
 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 Scoring and Weighting Methodologies
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 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.
Figure 1
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| Standardized Factors Used In Style And Pure Style Indexes |
| Growth Factors |
Value Factors |
| Five-year historic earnings/share growth |
Book-to-price |
| Five-year historic sales/share growth |
Cash flow-to-price |
| Five-year average internal growth rate* |
Sales-to-price |
| * Internal Growth Rate=Return on Equity (ROE) X (1-Payout Ratio) |
Dividend Yield |
|
Source: Standard and Poor's, S&P U.S. Style Indices: Teleconference
Presentation, September 20, 2005.
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.
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