This post is one of a series looking at returns in the decade after the financial crisis.
Many of the passive investing luminaries such as Bernstein, Swedroe, Ferri, and Hale (though not Bogle or friend of Monevator Lars Kroijer) discuss the higher returns you might be able to garner through exposure to the value and small cap factors.
It’s simple to do these days. You buy your entry ticket (not necessarily a winning one) by concentrating a portion of your portfolio on the bargains (value equities) and minnows (small cap equities) found in most stock markets.
Value and small cap companies are known to be riskier than average. The upside is they’ve historically delivered higher returns, if you’ve been patient and prepared to ride out a decade or more of disappointment.
Well I’ve read the books and I was prepared for disappointment. Which is lucky because that’s exactly what I got.
As usual, Trustnet provides the chart that tells our story1:
Specifically it was the disappointment of my choice – the value factor – represented in the table by the Invesco FTFSE RAFI All-World 3000 ETF (yellow line B).
Value equities have had a bad decade. The RAFI ETF only managed an annualised return of 9.4% versus the MSCI World’s 12.1% (red line C). (See our first article for more on the latter’s stellar run.)
Vanguard’s Global Small Cap Index fund (green line A) wasn’t launched until January 2010, but it’s marginally outperformed the MSCI World since then. At least that supports the possibility that the higher expected returns found in academic theory and the historical record haven’t yet been entirely quashed by the popularity of factor investing.
Of course less than ten years isn’t a very long time, and my books had told me that investments can fail to bear fruit for a decade or two, or even a lifetime. But reading about risk and then experiencing it with your own money is as different to watching someone else getting kicked in the nuts and then having it happen to you.
Rick Ferri warned that factor investing is a lifetime commitment. Jack Bogle warned that the only certainty is the higher fees.
What else can I add? Here’s to not getting kicked in the nuts for the next ten years.
Dividends didn’t really pay dividends
While it was far from the sort of disaster we’ve seen in some previous reviews (*cough* commodities) another strategy that failed to cover itself in glory over the last decade was dividend investing – at least judging by the global dividend tracker available at the time (grey-blue line D).
This might come as a bit of a surprise. Dividend investing was the recipient of a lot of buzz a few years ago, as plummeting bond yields in the wake of the Global Financial Crisis made divi-paying equities a popular alternative for income seekers.
As ever though, there is no free lunch. The danger of a portfolio that concentrates on high dividend equities is that this focus on income payers – often more mature, less growth-y companies – may mean that total returns lag those of the broad market.
And lo, our example high dividend ETF brought in 10.7% annualised versus that 12.1% for MSCI World.
Take it steady,
The Accumulator
We’ll continue to gaze back 10 years to see how several other passive-friendly strategies have fared. Subscribe to get all the posts.
There’s a pretty clear message coming through from this 10 year retrospective series!
@rhino
Let me guess; Trump is gr8 and tech is bada$$?
A while ago I wanted to look at passive index for mid-size companies. That was a struggle until I discovered ‘small’ can mean mid-sized by capitalisation. Bought iShares msci world size factor. According to Morningstar this has 20% in large and 78% in medium capitalised companies, with 0.68% in ‘small’. Other funds/ ETFs differed in this so you have to be careful as to what small means in a name.
The vanguard global small cap index is almost 50:50 medium: small ( Morningstar again).
I think that perhaps the issue is that it’s not (yet?) possible to catch these factors passively at present. I have no doubt there are articles in the Monevator archives showing how the same companies crop up in both Growth and Value ETFs, making it a bit of a mockery.
Similarly, small-cap is tricky as the indices tend to be very skewed, making them much easier for Active managers to outperform (especially in e.g. Asia).
As for the Frontier 100 – don’t get me started!
I’m a naughty active investor, but I will grant that the S&P500 is the one index that is almost impossible to outperform (and so it follows that MSCI World will also be pretty tough).
Thanks as always for these articles which are thought-provoking as ever!
@NL – fair enough, maybe the message isn’t that clear
Equity factors, home country bias, commodities, specialist funds … this retrospective is all very well and good but where are the bonds?
@ZX coming next I would imagine? I wager you’ll offer up a well-informed but slightly punishing review as and when?
Value and dividend investing has clearly done badly over the last 10 years, my experience over the prior 20 years was great, maybe the tide will turn, but when….
Bernstein made an analogy of factor investing to a favourite Umbrella ship in Paris, when it’s attractions become more widely known, it became more crowded and less of a bargain…
Overseas dividend investing also suffers from slightly higher costs, say .2 to .3% pa and higher withholding taxes of another .3% perhaps…perhaps a bit more turnover… that’s a drag against the factor bonus.
Interesting series of articles on the ten year retrospective.
Like a lot of stories the happy ending depends on where you start and end
As a retired income investor I accept that I´m sacrificing capital growth for income security. It´s more important for me to know that my income will be maintained during market crashes such as that of 2008. My portfolio of income Investment Trusts provided me with an above inflation rate income during those difficult years. Not a strategy for everyone but works for me.
An excellent summary of the factor/quant Winter since~2010 from over at the FT:
https://www.ft.com/content/e0f98278-432e-4ece-b170-2c40e40d2835
There’s an awful lot which could be said on this subject. ‘Factor’ investment has a great deal of nuances, both at the level of theory and in its manifold implementations.
Value and small cap have lagged, but equally the performance of momentum and low volatility have been rather more impressive.
And small cap value (which may account for all or most of any small cap premium) is at nearly its cheapest relative valuation level of all time.
And with multifactor ETFs it is in principle possible to achieve an automated rebalance bonus between the ‘factors’ used.
There is an issue that factor exposures in mainstream ETF implementations may be quite tepid.
In any event, I would be slow to write off this area myself.