The Syntax Approach
Syntax takes the world’s most widely used benchmarks and re-weights them using our patented Stratified Weight methodology to diversify business risks. Traditional cap-weighting index strategies do little to diversify the concentration of related business risks—the shared risks of companies with similar business models. Instead, cap weighting causes an investor’s ownership to accumulate in the largest, most momentum-driven companies and industries. Investors need to properly manage related business risk to achieve the most consistent equity risk premium. Syntax’s family of Stratified Indices offer balanced exposures across business types. The result is better diversification.
Fixing Bias in the Market Index
Syntax Stratified Weight Indices aim to reduce the bias in the most widely followed indices. The simplicity of cap-weighting has enabled it to become the default methodology for passive investments globally. However, with the growing popularity of alternative weight indices, the investment community has begun to question whether cap weight is the optimal way to gain broad-based market exposure. While conventional wisdom says a cap-weighted index captures a diversified equity risk premium simply by holding a sufficiently large number of constituents, this is often not the case.
The core problem with cap weight as a diversification strategy is that it has no explicit risk controls. The risk exposures of a cap-weighted index will change with the general ebb and flow of markets and its level of diversification will also change over time. Left unconstrained, cap weight creates biases (risk concentrations) affecting both individual companies and groups of related stocks.
By construction, a cap-weighted index is tilted toward the largest companies. This introduces a significant skew towards a few large-cap companies. Some alternative weight strategies like equal weight attempt to correct this bias. But cap weight also holds another bias: the overweighting of related business risks.
Build Business Risk Groups
For too long, investors have been exposed to a type of risk that has not been adequately identified, let alone addressed, in the marketplace. We call this risk Related Business Risk (RBR): the risk that two or more businesses will react similarly to market events. By leveraging nearly two decades’ worth of economic research, Syntax has developed a solution designed to identify and manage this type of risk.
Related Business Risk can be measured by the underlying economic characteristics of companies. Investors will often analyze financial metrics of individual companies, which can be good indicators of idiosyncratic risk, but they do not adequately analyze the risks a given firm shares with other companies. This can expose large parts of a portfolio to risks that are not seen when studying individual companies.
Syntax has developed a patented classification system called the Functional Information System (FIS) that allows us to study a company’s function in the economy by applying standardized markers associated with a company’s products, its customers, and its supply chain, among other characteristics. These markers allow us to identify and measure the impact of business risks on company performance.
Our research has found that these functional markers correlate with the business risks a company faces. This is the foundation for the concept of Related Business Risk, and it is fairly intuitive: companies engaged in the same business should move together in the market.
Take, for example, Ford and GM, two companies with nearly identical business models, sharing similar customers, suppliers, and products, among other functional markers. A shock to any one of these functional categories would affect both companies’ business fundamentals and, in turn, their share prices. This could include everything from high oil prices hurting car sales to a labor strike halting production to shifting regulatory conditions, customer trends, or even natural disasters. Given that their shared functional markers have real market implications, Ford and GM share Related Business Risks.
By grouping companies with shared RBRs, we can assemble effective risk groups to diversify business risk. The result is a index that diversifies both idiosyncratic risk and related business risk.
Syntax diversifies Related Business Risk through a novel index weighting methodology called Stratified Weight. The objective of stratified weight is to maintain equal exposure across RBRs, capturing all the economic opportunities in an index. If left uncontrolled, an index can become dangerously concentrated in a particular RBR that negatively impacts its performance.
The foundation for Stratified Weight comes from the medical field, where clinical drug trials use a method called stratification to control for unintended biases. In drug trials, stratification places patients into homogenous groups based on shared characteristics, such as gender, age, and medical history. The groups are then assigned equal significance, so that the results from one group count as much as the results of another group. Stratification is widely employed in medical clinical trials to control for shared risks among patient participants, but has until now never been used to control for risk in stock indices.
Syntax’s approach to stratifying investment securities is no different from how healthcare professionals stratify in clinical trials. Instead of grouping patients with related health risks, Syntax groups companies with Related Business Risks. And just as an overweighting in one patient group can skew the results of a clinical trial, an overweighting in one RBR group can negatively impact index returns. To address this, Syntax Stratified Indices cap the contribution of any one group as a percentage of the overall population, like in clinical trials. The result is a well-diversified index that controls for unintended overweightings in related business categories without sacrificing upside returns.
Stratified Weight Index
The Stratified Index directly addresses the related business biases in cap weighting. The objective of Syntax Stratified Indices is to capture the broad equity risk premium for the universe. This goal is difficult to achieve by concentrating in the largest companies or the hottest sectors, as cap weighting does, but can be realized through business risk diversification. Stratified Indices are designed to be an investor’s core equity exposure.
The Stratified Performance Difference
The key to Syntax’s Stratified-Weight performance comes from controlling for Related Business Risk events. See how controlling for such events has demonstrated outperformance across sectors, geographies and market environments.
Outperformance Across Sectors
Stratifying business risk categories markedly improved performance over cap-weighting in both composite indices like the Syntax Stratified Core and the sector indices that form these composites.
In a backtested study going back 25 years using performance data calculated by S&P Dow Jones Indices, every Syntax Stratified Sector index, as well as the equally-weighted composite of these sectors, outperforms its cap-weighted analog. In the chart below, each pair of bars contains the exact same securities at each point in time; the only difference in performance comes from the weighting method used.
Outperformance Across Market Environments
The benefits of Stratification are also seen across different types of markets. While improved diversification shows the most benefit in down markets, it also outperforms the majority of the time in bull markets.
The performance results over the last 25 years reflect several different market environments. The chart below divides this time period into four subsets: the run-up to the internet bubble, the aftermath, the subsequent financial crash, and the current bull market. Each chart shows the performance of the S&P 500 and the Syntax Large Cap Index over each period.
The consistency of stratified-weight’s performance in these four time periods has led to significant risk-adjusted returns over long holding periods.
FIS: Sequencing Business DNA
To identify Related Business Risks, Syntax uses its patented multi-attribute Functional Information System (FIS).
Just as every person has 23 unique chromosomes that carry our genetic information and make each of us who we are, each company in the economy has its own set of “chromosomes” – products, services, employees, customers – that make it unique.
Using FIS, Syntax codifies the DNA of business structures, and assigns each company in the economy its own FIS barcode based on its real economic characteristics: what it produces, who it sells to, and how its product is used in the larger economic system, among other factors.
In genetics, biomarkers associated with a specific function correlate with a particular biological activity. For example, oncogenes are functional markers associated with cancers. In economics, FIS works the same way: FIS codes are functional markers that correlate with a particular economic activity.
FIS assigns standardized barcodes of functional markers to individual companies. Each marker in an FIS Barcode represents an area of shared business risk. These barcodes offer a standardized and multi-dimensional system to capture the business risk attributes that drive a given company's performance. This is information that Syntax can then use to identify Related Business Risks.
Rigorously developed over more than 15 years, FIS represents a breakthrough in the selection of risk groups used in index construction. FIS can be used to define customized risk groups for virtually any collection of investable securities on a rules-defined basis. To learn more about the FIS model, visit Locus Analytics.
Past performance is no guarantee of future results. All performance presented prior to the index inception date is back-tested performance, based on the methodology in effect on the launch date. Back-tested performance is not actual performance, but is hypothetical. The inception date of the Syntax Stratified Core, Syntax Stratified Financials, Syntax Stratified Energy, Syntax Stratified Industrials, Syntax Stratified IT, Syntax Stratified Information, Syntax Stratified Consumer, Syntax Stratified Food, Syntax Stratified Healthcare, and Syntax Stratified LargeCap Indices (“the Indices”) is 12/27/2016. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight. No theoretical or back-tested approach can account for all market factors and the impact of decisions that might have been made during the actual operation of an index. Actual returns may differ from, and be lower than, back-tested returns, which are not necessarily predictive of future returns. The base index value is set as of 100 as of the initial back-test date of 12/20/1991. Charts and graphs are provided for illustrative purposes only.
The Indices are the property of Locus Analytics, LLC, which has contracted with S&P Dow Jones Indices to calculate and maintain the Indices. The Indices are not sponsored by S&P Dow Jones Indices or its affiliates or its third party licensors (collectively, “S&P Dow Jones Indices”). S&P Dow Jones Indices will not be liable for any errors or omissions in calculating the Index. Calculated by S&P Dow Jones Indices” and the related stylized mark(s) are service marks of S&P Dow Jones Indices and have been licensed for use by Locus Analytics, LLC. S&P® is a registered trademark of Standard & Poor's Financial Services LLC (“SPFS"), and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). Syntax®, Stratified®, Stratified Indices®, Stratified-Weight™, and Locus® are trademarks or registered trademarks of Locus Analytics, LLC.
Index performance does not represent actual fund or portfolio performance and such performance does not reflect the actual investment experience of any investor. An investor cannot invest directly in an index. In addition, the results actual investors might have achieved would have differed from those shown because of differences in the timing, amounts of their investments, and fees and expenses associated with an investment in a portfolio invested in accordance with an index. None of the Syntax Indices or the benchmark indices portrayed herein charge management fees or incur brokerage expenses, and no such fees or expenses were deducted from the performance shown; provided, however, that the returns of any investment portfolio invested in accordance with such indices would be net of such fees and expenses. Additionally, none of these indices lend securities, and no revenues from securities lending were added to the performance shown. Performance shown is unaudited and subject to revision. This site may include materials and documents containing forward-looking statements which are based on our expectations and projections as of the date made. Past returns are not necessarily predictive of future returns.
The S&P 500® Index is an unmanaged index considered representative of the US large-cap stock market. The S&P 500® Equal Weight Index is an equal-weighted version of the S&P 500® Index. The S&P 400® is an unmanaged index considered representative of the US mid-cap stock market. The S&P 400® Equal Weight Index is an equal-weighted version of the S&P 400® Index. The S&P 900® Index is an unmanaged composite of the S&P 500® and S&P 400® Indices. Benchmark data for the S&P 900, S&P 500, and S&P 500 Equal Weight Indices are provided by S&P Dow Jones Indices. The capitalization-weighted Syntax Stratified sector benchmarks are calculated by Syntax via FactSet®.