As January 1st passes, there have been stories all over the financial press
about the “Lost Decade” for US Equities. These headlines
are certainly eye-catching and feed on investor’s recent memories of
2008 where the S&P 500 lost -37% in 12 months, and another -11% through
the first quarter. These articles are spot on when it comes to the
S&P 500, a large cap US equity index, which had an annualized loss of
almost -1% per year over the past decade. The Russell
3000 index, which incorporates large, mid, and small cap stocks also suffered
an annualized loss of -0.20% during the past ten years. In
order to understand the differences between these two indices, we need to
explore what makes up the Russell 3000.
Nine US Equity Styles
The Russell 3000 index can be broken into nine separate components. The
subparts are split up by the size of the companies issuing the stocks (Large,
Mid, and Small), as well as the relative strength/value of each stock (Value,
Blend, and Growth). Doing so allows us to see a very different story:
This chart illustrates that across all market caps, Value stocks significantly
outperformed their Blend and Growth counterparts. Investors who
held Small Value stocks should have seen them return +8.27% per
year through the past decade. The chart also illustrates that
Small and Mid Cap stocks outperformed their large counterparts in all
categories over the past decade.
RWM’s investment philosophy in the US Equity market is to emphasize
Small and Value stocks, while owning a percentage of each category. Over
this timeframe, that strategy has added value compared to a more market
neutral index, such as the Russell 3000, due to its allocation to Small
and Value stocks.
It’s also important to understand that while we believe Small
and Value stocks will offer long term excess returns over a more market
neutral strategy, over shorter time periods, that emphasis may underperform
the market. For instance, Small Value stocks gained +20.6% in
2009 compared to the Russell 3000’s gain of +28.3%,
however even this lower relative performance didn’t stop Small
Value stocks from beating the Russell 3000 by nearly +8.5% annually
in the last decade. RWM’s focus in the US Equity market
is to have exposure to all sectors, so that we will experience the
market return, while emphasizing Small and Value stocks which have
demonstrated added value over longer periods of time.
International Equity Exposure
We also still believe that an allocation to Developed International
Markets and Emerging International Markets play a role in diversified
portfolios. As we saw in 2008, US and International markets
can move in the same direction, as International stocks lost over -45% and
Emerging Market stocks fell -53%. However, these
markets snapped back even stronger in 2009, gaining +31.8% and +78.5% respectively. The
ten year annualized returns also exceed that of the broad US Equity
markets, and we can see that Value stocks in the Developed International
Markets exceeded the returns of the market neutral index:
Fixed Income Allocation
Finally, it’s important to discuss the importance of bonds within
a diversified portfolio. Bonds serve as a counter weight within
your portfolio, adding stability during times of economic stress, while
providing real returns to investors. Like the trend we discussed
in the US Equity markets, bonds can, at times, actually lose value. We
expect that those losses, however, will be significantly smaller than
those of the stocks, and will likely occur at a point when stocks are
in favor and are gaining value. As the chart below illustrates,
adding 10% of a broad market bond fund to the Russell 3000 index over
the last ten years would have changed the portfolio’s return
from an annualized loss to a gain.
The Next Decade
While many analysts are trying to predict at what level the Dow will
close on December 31st of this year, we believe that the lessons from
the last decade and dating all the way back to the 1920s and 1930s
are still very relevant to investors:
- Eliminate unnecessary risk from your portfolio, including individual
company risk and sector risk - Have broad and diversified exposure among
your holdingsSmall and Value stocks will likely add value over time - Having
exposure to Developed and Emerging International markets will likely
add value over time - Pick an appropriate allocation to stocks and bonds
that will allow you to stay the course in turbulent markets - Do not
allow short term market disruptions to disrupt your long term plans,
as this will likely result in selling low and buying high - Execute
your investment strategy as efficiently as possible
About
Raffa Wealth Management is an independent investment advisor providing
nonprofit organizations and high net worth individuals with a full range
of investment consulting services. We were established to fill
the need for transparency, clarity, and vision in the professional management
of investment assets. Visit us at www.raffawealth.com.
Important Disclosure
Past performance is not a guarantee of future results and there is
always a risk that an investor may lose money. Information contained
has been gathered from sources we believe to be reliable, but we do
not guarantee the accuracy or completeness of such information. Indices
are not available for direct investment and performance does not reflect
expenses of an actual portfolio. Such expense would reduce the returns
illustrated. Returns are shown gross RWM’s advisory fee.
The incurrence or inclusion of an advisory fee will have the effect
decreasing performance results. For example an advisory fee of
1% compounded over a ten year period would reduce a 10% return to an
8.9% annual return. RWM’s form ADV is available upon
request. The form ADV is the RIA disclosure document that outlines
material arrangements and business practices.