Investors love good stories and in recent years, many of these stories have centered around innovations that have fundamentally changed the way we live our lives. Some examples might include the release of the original Apple iPhone in 2007, the delivery of Tesla’s first electric cars in 2012 and the launch of Amazon Prime’s same-day delivery service in 2015.
No doubt, many of you will have had conversations with friends and family around the successes, failures, and prospects of some of the world’s largest companies and the goods and services they offer. In this article, we take a deeper look at the ‘Big Five’ tech companies – Amazon, Apple, Alphabet (Google), Facebook and Microsoft – through the lens of the long-term investor.
The ‘Big Five’, images from Unsplash [1]
In what has been a turbulent year thus far, some larger firms have come through the first, and hopefully last, wave of the ongoing pandemic relatively unscathed. Those investors putting their nest eggs entirely in any combination of the ‘Big Five’ would appear to have done astonishingly well relative to something sensible like the MSCI All-Country World Index, which constitutes 3,000 of the world’s largest companies. At time of writing, Amazon’s share price has faired best, increasing 75% since the beginning of the year.
These types of firms tend to struggle to stay out of the headlines for one reason or another. Perhaps as a result, many of the investment funds found in ‘top buy’ lists have overweight positions in one or more of these companies. Many of today’s most popular funds are making big bets on one or more of these companies, anticipating that the past will repeat itself moving forwards.
Sticking to the long-term view
The challenge for these managers, and others making similarly large bets, is that these are portfolios that will be needed to meet the needs of individuals over lifelong investment horizons, which for the vast majority of people means decades, not years. With the benefit of hindsight, managers who have placed their faith in these companies have stellar track records since Facebook’s listing on the market in 2012.
However, an interesting exercise would be to investigate the outcomes of these companies over a longer period of time, for example 30-years seems more prudent. This is somewhat difficult given that 30-years ago, 3 of these companies did not exist, Mark Zuckerberg of Facebook was 6-years old, Apple came in at 96th on Fortune’s 500 list of America’s largest companies and Microsoft had just launched Microsoft Office.
A partial solution to this problem is to perform the exercise from the perspective of an investor in 1996, which is the start of Financial Times’ public market capitalisation record.
The ‘Class of 96 Big Five’ consisted of General Electric, Royal Dutch Shell, Coca-Cola, Nippon Telegraph and Telephone and Exxon Mobil. A hypothetical investor with their assets invested in either Coca-Cola or Exxon would have just about beaten the market over this period, those in Royal Dutch Shell, Nippon Telegraph and Telephone and General Electric were not so lucky.
This exercise is illustrative only, however a closer look is enough to see that almost no investor would want to stomach the roller coaster ride they would have been on in any one of these single-company portfolios.
Summary
The beauty of the globally diversified, systematic approach adopted by Wells Gibson, is that judgemental calls such as these are left to the aggregate view of all investors in the marketplace.
No firm is immune to the risks and rewards of capitalism; be it competition from Costco or Walmart taking some of Amazon’s market share, publishing laws causing Facebook to apply heavy restrictions on its users or some breakthrough smartphone entering the marketplace that is years ahead of Apple – remember Nokia?
Rather than supposing that companies who have done well recently will continue to do well, systematic investors can rest easy knowing that they will participate in the upside of the next ‘Big Five’, the ‘Big Five’ after that and each subsequent ‘Big Five’.
Those who can block out the noise of good stories and jumping on bandwagons are usually rewarded over time.
“But the problem that people don’t understand is that active managers, almost by definition, have to be poorly diversified. Otherwise, they’re not really active. They have to make bets. What that means is there’s a huge dispersion of outcomes that are totally consistent with just chance. There’s no skill involved in it. It’s just good luck or bad luck.”
One of the hardest concepts to grasp in investing is that a ‘good’ company is not always a better investment opportunity than a ‘bad’ company.
If we believe that markets work pretty well, considering few investment professionals beat the market over time, and markets incorporate all public information into prices pretty quickly and efficiently, all of the ‘good’ and ‘bad’ news should already be reflected in these prices.
A ‘good’ company will have to do better than the aggregate expectation set by the market for its share price to rise and vice versa. If a ‘bad’ company is in fact a less healthy company, it may have a higher expected long-term return, as risk and return are related.
It is perhaps evident that if the market incorporates the aggregate forward-looking views of all investors, it becomes very difficult to choose which companies, sectors, and geographic markets are likely to do best, going forward.
In an uncertain world, where equity prices could move rapidly, and with magnitude, on the release of new information, which is itself a random process, then it makes good sense to ensure that an investment portfolio remains well diversified across companies, sectors and geographies.
Many charts illustrate how deeply diversified a globally equity portfolio can be however if you do not know which companies are going to perform well, own them all. However, in the US, the concentration risk of the S&P500, is quite different and is increasingly concentrated in a few names.
Given that all the future promise of a company is already reflected in its share price today, it is quite a risk betting a large part of your assets on just a few names, concentrated, for example, in the technology sector. The top 8 technology shares in the US now have a larger market capitalisation than every other non-US market except for Japan!
Dominance of companies, sectors and markets ebb and flow over time. What will be the next Amazon? What regulatory pressures could these dominant companies face? Is Donald Trump’s recent rage against Twitter the start? No-one knows.
By remaining diversified, you will own the next wave of market leaders as they emerge and dilute the impact of ebbing companies. Whilst it is always tempting to look back with the benefit of hindsight and wish we had owned more (take your pick), US tech shares, other growth shares, gold etc., what matters is what is in front of us, not what is behind us.
As always please get in contact if you have any questions.
It’s been another tough week for capital markets however, context is an extremely important tool when it comes to investing.
All investors around the world will be feeling the emotional pressures of the recent rapid equity market falls, either because they can remember previous falls and times of uncertainty, such as the Global Financial Crisis (2007-2009), or as younger investors, they have not yet experienced material market falls.
We obviously cannot see into the future, however the global equity market falls we have seen since January, of under 20% or so at the time of writing, sit well within previous falls since 1970.
In terms of expected ranges of outcomes, we generally estimate that 95% of the time annual equity market returns should sit within an approximate range of + 45% to – 35% albeit outliers do exist beyond these limits.
The table below provides numbers around both the depth and recovery times for each of the five largest falls since 1970.
Peak date
Decline
Trough date
Recovery date
Decline
(months)
Recovery (months)
Sep-00
-49%
Jan-03
Dec-10
29
95
Jan-73
-40%
Sep-74
Jan-76
21
16
Jan-90
-35%
Sep-90
Jan-93
9
28
Sep-87
-29%
Nov-87
Mar-89
3
16
Jan-70
-19%
Jun-70
Jan-71
6
7
Jan-20
-19%
–
–
–
–
How deep or long the current fall will be, no-one knows.
There will certainly be more rises and falls to come. Yet we should take some comfort from the fact that things have been just as challenging at times in the past, albeit for very different reasons. Recovery times sit well within the investment timeframes of most investors. It is worth noting that an investor in global equites today has, in nominal terms, more money than they did at the end of April 2018, despite the market falls in late 2018 and those recently experienced.
These are tough times for all of us and for our Nation, but the words of wisdom that we always return to at these times are those of the legendary investor John Bogle, “This too will pass.”
This will pass and from an investment perspective, the key message is to be brave and disciplined as a fall only becomes a loss if we sell.
Remember, we are always available to take your call or answer your emails. Please feel free to contact Wells Gibson, if you have any specific questions or simply if you would like some reassurance.
From 1975–2017 the value premium[1]in Europe has had a positive annualised return of approximately 2.2%.[2]In six of the last ten calendar years, however, the value premium in Europe has been negative. The same trend has been seen across developed markets globally.
[1]. The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
[2]. Computed as the return difference between the Fama/French Europe and Scandinavian Value Research Index and the Fama/French Europe and Scandinavian Growth Research Index. Fama/French indices provided by Ken French. Index descriptions available upon request.
This has prompted some investors to wonder if such an extended period of underperformance may be cause for concern. But are periods of underperformance in the value premium that unusual? We can look to history to help make sense of this question.
There are numerous empirical studies documenting the value premium using different empirical techniques on 90 years of US data as well as over 40 years of data for developed markets outside of the US that point to reliably positive premiums in the long term.
SHORT-TERM RESULTS
Exhibit 1 shows yearly observations of the US value premium going back to 1928. We can see the annual arithmetic average for the premium is close to 5% in USD terms, but in any given year the premium has varied widely, sometimes experiencing extreme positive or negative performance. In fact, there are only a handful of years that were within a 2% range of the annual average—most other years were farther above or below the mean. In the last 10 years alone there have been premium observations that were negative, positive, and in line with the historical average. This data helps illustrate that there is a significant amount of variability around how long it may take a positive value premium to materialise.
[1]. The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
[1]. Computed as the return difference between the Fama/French Europe and Scandinavian Value Research Index and the Fama/French Europe and Scandinavian Growth Research Index. Fama/French indices provided by Ken French. Index descriptions available upon request.
In US dollars. The one-year relative price premium is computed as the one-year compound return on the Fama/French US Value Research Index minus the one-year compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actualportfolio.Past performance is no guarantee of future results.
LONG-TERM RESULTS
But what about longer-term underperformance? While the current stretch of extended underperformance for the value premium may be disappointing, it is not unprecedented. Exhibit 2 documents 10-year annualised performance periods for the value premium within the US market, sorted from lowest to highest by end date (calendar year).
This chart shows us that the best 10-year period for the value premium was from 1941–1950 (at top), while the worst was from 1930–1939 (at bottom). In most cases, we can see that the value premium was positive over a given 10-year period. As the arrow indicates, however, the value premium for the most recent 10‑year period (ending in 2017) was negative. To put this in context, the most recent 10 years is one of 13 periods since 1937 that had a negative annualised value premium. Of these, the most recent period of underperformance has been fairly middle-of-the-road in magnitude.
Exhibit 2. Historical Observations of 10-Year Premiums, Value minus Growth: US Markets 10-Year Periods ending 1937–2017
In US dollars. The 10-year rolling relative price premium is computed as the 10-year annualised compound return on the Fama/French US Value Research Index minus the 10-year annualised compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.Past performance is no guarantee of future results.
While there is uncertainty around how long periods of underperformance may last, historically the frequency of a positive value premium has increased over longer time horizons. Exhibit 3 shows the percentage of time that the value premium was positive over different time periods going back to 1926 for the US market and 1975 for developed markets outside of the US. When the length of time measured increased, the chance of a positive value premium increased.
Exhibit 3. Historical Performance of Premiums over Rolling Periods, US Markets, July 1926–December 2017
Historical Performance of Premiums over Rolling Periods, Developed ex-US, January 1975–December 2017
In US dollars. Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
For example, we can see that the realised value premium over a one-year horizon (using overlapping periods) has been positive around 61% to 69% of the time across US and developed ex US markets. When the time period measured is lengthened to 10 years, the frequency of positive average premiums increased to 84% and above.
CONCLUSION
What does all of this mean for investors? While a positive value premium is never guaranteed, the premium has historically had a greater chance of being positive the longer the time horizon observed. Even with long-term positive results though, periods of extended underperformance can happen from time to time. Because the value premium has not historically materialised in a steady or predictable fashion, a consistent investment approach that maintains emphasis on value stocks in all market environments may allow investors to more reliably capture the premium over the long run. Additionally, keeping implementation costs low and integrating multiple dimensions of expected stock returns (such as size and profitability) can improve the consistency of expected outperformance.
Source: Dimensional Fund Advisors LP.
The views and opinions expressed in this article are those of the author and not necessarily those of Dimensional Fund Advisors Ltd. (DFAL). DFAL accepts no liability over the content or arising from use of this material. The information in this material is provided for background information only. It does not constitute investment advice, recommendation or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision.
The content, style and messages the material delivers are presented for consideration and should be tailored to your firms own beliefs, message and brand.
DFAL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DFAL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to an affiliate of Dimensional Fund Advisors Ltd.
The Dimensional and Fama/French Indices reflected above are not “financial indices” for the purpose of the EU Markets in Financial Instruments Directive (MiFID). Rather, they represent academic concepts that may be relevant or informative about portfolio construction and are not available for direct investment or for use as a benchmark. Their performance does not reflect the expenses associated with the management of an actual portfolio. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Descriptions of the Dimensional and Fama/French indexes available upon request.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful. Results shown during periods prior to each Index’s index inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.
After a period of relative calm in the markets, in recent days the increase in volatility in equity markets has resulted in renewed anxiety for many investors.
While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Additionally, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
INTRA-YEAR DECLINES
Exhibit 1shows calendar year returns for the US equity market, the world’s biggest, since 1979, as well as the largest intra-year declines that occurred during a given year. During this period, the average intra-year decline was about 14%. Approximately half of the years observed had declines of more than 10%, and around a third had declines of more than 15%. Despite substantial intra-year drops, calendar year returns were positive in 32 years out of the 37 examined. This goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline will result in negative returns over the entire year.
Exhibit 1. US Market Intra-Year Gains and Declines vs. Calendar Year Returns, 1979–2017
In US dollars. US Market is measured by the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
Past performance is not a guarantee of future results.
REACTING IMPACTS PERFORMANCE
Further complicating the prospect of market timing being additive to portfolio performance is the fact that a substantial proportion of the total return of equities / shares over long periods comes from just a handful of days. Since investors are unlikely to be able to identify in advance which days will have strong returns and which will not, the prudent course is likely to remain invested during periods of volatility rather than jump in and out of equities / shares. Otherwise, an investor runs the risk of being on the sidelines on days when returns happen to be strongly positive.
Exhibit 2 helps illustrate this point. It shows the annualised compound return of the S&P 500 Index going back to 1990 and illustrates the impact of missing out on just a few days of strong returns. The bars represent the hypothetical growth of $1,000 over the period and show what happened if you missed the best single day during the period and what happened if you missed a handful of the best single days. The data shows that being on the sidelines for only a few of the best single days in the market would have resulted in substantially lower returns than the total period had to offer.
Exhibit 2. Performance of the S&P 500 Index, 1990–2017
Past performance is not a guarantee of future results.
CONCLUSION
While market volatility can be nerve-racking for investors, reacting emotionally and changing long-term investment strategies in response to short-term declines could prove more harmful than helpful. By adhering to a well-thought-out investment plan, ideally agreed in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty.
