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Capitalism

Where’s the Value?

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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.

1

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

2

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

3

Historical Performance of Premiums over Rolling Periods, Developed ex-US, January 1975–December 2017

4

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.

Recent Market Volatility

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Recent Market Volatility

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 1 shows 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

Picture1

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

Picture2

In US dollars.  For illustrative purposes.  The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s).  Annualised returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global.  All rights reserved.  One-Month US T- Bills is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values.

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.

UK General Elections and the Stock Market

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Over the long run, the stock market has provided substantial returns regardless of who lives at Number 10.

Last week’s snap election was the first national vote in the UK since the EU referendum. Although we now know the outcome of the election, the overall impact is unknown. Furthermore, there is no shortage of speculation about how the election will impact the stock market. Below, we explain why investors would be well-served avoiding the temptation to make significant changes to a long-term investment plan based upon these sorts of predictions. Trying to outguess the market is often a loser’s game. Current market prices offer an up-to-the-minute snapshot of the aggregate expectations of market participants – including expectations about the outcome and impact of elections. While unanticipated future events (genuine surprises) may trigger price changes in the future, the nature of these events cannot be known by investors today. As a result, it is difficult, if not impossible, to systematically benefit from trying to identify mispriced securities. So, it is unlikely that investors can gain an edge by attempting to predict what will happen to the stock market after last week’s or any future general election.

The focus of last week’s election is Britain’s exit from the EU. However, as is often the case, predictions about its effect on the stock market focus on which party will be “better for the market” over the long run. Exhibit 1 below shows the growth of £1 invested in the UK market over more than 60 years and 12 prime ministers (from Anthony Eden to Theresa May).

Exhibit 1: Growth of a Pound Invested in the Dimensional UK Market Index

January 1956–December 2016.

Growth of a Pound Invested in the Dimensional UK Market Index graph

For illustrative purposes only. Past performance is not a guarantee of future results. Index is not available for direct investment therefore the performance does not reflect the expenses associated with the management of an actual fund. Dimensional indices use CRSP and Compustat data. See “Index Descriptions” below for descriptions of index data.

The above exhibit does not suggest an obvious pattern of long-term stock market performance based upon which party has the majority in the Commons. What it shows is that over the long-term, the market has provided substantial returns regardless of who lives at Number 10.

Equity markets can help investors grow their assets, but investing is a long-term endeavour. Trying to make investment decisions based upon the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely result from random luck. At worst, such a strategy can lead to costly mistakes and the erosion of wealth.

Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, in pursuit of investment returns – we call it ‘Sensible Investing’.

Jonathan Gibson
Managing Director

INDEX DESCRIPTIONS

Dimensional UK Market Index: Compiled by Dimensional from Bloomberg securities data. Market capitalisation-weighted index of all securities in the United Kingdom. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to April 2008.

Investments involve risks. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, might be worth less than their original cost.

The views and opinions expressed in this article are those of the author. Past performance is not a guarantee of future results. There is no guarantee, strategies will be successful. The information in this article 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.

Top trump your investments in 2017…

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People love to make predictions, especially in January, when everyone is looking forward to the year ahead. Furthermore, this January we now have Donald Trump as the new US President and the most powerful man on the planet and the leader of the world’s largest economy to consider.

However, it’s fair to say that when it comes to investing, accurate forecasting is practically impossible, and, even when a prediction turns out to be accurate, it is hard to say whether it was the result of luck or skill.

Rather than speculating and relying on predictions for your investment strategy, as many people do, a more sensible approach is to make assumptions based on decades of evidence from market data and academic analysis. In other words, it’s probably best to assume that:

o Capitalism will remain the world’s preeminent economic model and will continue to provide a steady return to those invested in it.

o On average, certain types of security will perform better than others over time, so it is worthwhile focusing on those in your portfolio.

o Holding a high number of lower-risk, defensive assets and higher-risk, growth assets, will help manage risk and increase the reliability of investment returns.

You could argue that these statements are predictions themselves because they relate to future events. But which would you rather have form the basis of your investment strategy and your financial future? These three statements—or, as is the case with many conventional, investment strategies, the changing guidance of a small group of investment insiders and speculators (or so-called experts)?

Some forecasts, however, are worth making in relation to your own financial planning—generally those over which you have a degree of influence. For instance, when you plan to retire and how much money you will need to meet your desired lifestyle. Sensible judgements like these are key to forming an effective financial plan.

Making fun forecasts about sports results or speculating about the direction of the pound or the fate of the eurozone is one thing. Basing your investment strategy and your financial future on forecasts and speculation is something else altogether and is certainly not wise.

Sensible investing is possible if you work with a financial planning and investment company which starts with information you know is supported by decades of evidence and then builds their investment philosophy and strategy around it – this way you can top trump your investment plan in 2017 and improve your chances of pursuing a better investment experience.