At Keener Financial Planning, we use broad diversification as part of a long-term, low-cost investment strategy. We also find the long-term data on the performance benefits of over-weighting small and value companies compelling. Because these strategies affect investment performance, we like to monitor how they do around the globe.
In 2018, the MSCI Emerging Markets Value Index (IMI) outperformed its growth counterpart (−11.5% vs. −18.4%). In developed markets, however, this was not the case. The Russell 3000 Value Index underperformed the Russell 3000 Growth Index (−8.6% vs. −2.1%) and the MSCI World ex USA Value Index (IMI) underperformed its growth index counterpart (−15.6% vs. −13.8%). Small cap stocks generally underperformed large cap stocks globally. For example, the Russell 2000 Index returned −11.0% relative to −4.8% for the Russell 1000 Index. Similarly, the MSCI World ex USA Index outperformed its small cap counterpart (−14.1% vs. −18.1%), and the MSCI Emerging Markets Index outperformed its small cap counterpart (−14.6% vs. −18.6%).
The mix of relative performance of value vs. growth stocks within and across regions this year serves as a reminder of the importance of integrating premiums when designing and managing portfolios. Within US equity markets, when at least one of the size, value, and profitability premiums has been negative in a given year, at least one of the other factors was positive 81% of the time.4 Positive premiums can contribute to relative returns during time periods when other premiums are negative.
In the US, small cap stocks underperformed large cap stocks, and value stocks underperformed growth stocks using Russell indices. The Russell 2000 Index declined −11.0% for the year vs. −4.8% for the Russell 1000. The Russell 3000 Value Index returned −8.6% in 2018 vs. −2.1% for the Russell 3000 Growth Index. The variation in returns between these indices is within historical norms. Since 1979, there has been an annual return difference of 6% or greater 60% of the time.
Developed ex US Markets
In developed ex US markets, small cap stocks underperformed large cap stocks and value stocks underperformed growth stocks. Despite underperformance in 2018, over both five- and 10-year periods, small cap stocks, as measured by the MSCI World ex USA Small Cap Index, have outperformed large caps, as measured by the MSCI World ex USA Index. Growth stocks, as measured by MSCI World ex USA Growth Index (IMI), returned −13.8%, outperforming value stocks, which returned −15.6% in 2018, as measured using the MSCI World ex USA Value Index (IMI).
In emerging markets, small cap stocks, as measured by the MSCI Emerging Markets Small Cap Index, underperformed large cap stocks, as measured by the MSCI Emerging Markets Index. However, over the past 10 years, small caps returned an annualized 9.9%, outperforming large caps, which returned 8.0%.
Value stocks returned −11.5% as measured by the MSCI Emerging Markets Value Index (IMI), outperforming growth stocks, which returned −18.4% using the MSCI Emerging Markets Growth Index (IMI). This was the sixth largest outperformance of value over growth in emerging markets since 1999.
The complementary behavior of size (small vs. large) and relative price (value vs. growth) in emerging markets in 2018 is a good example of the benefits of diversification. While small cap stocks underperformed, diversified portfolios were buoyed by outperformance among value stocks. This integration can increase the reliability of outperformance and mitigate the impact of an individual asset group’s underperformance.
Despite recent years’ headwinds, the size, value, and profitability premiums remain persistent over the long term and around the globe. It is well documented that stocks with higher expected return potential, such as small cap and value stocks, do not realize outperformance every year. Maintaining discipline to these parts of the market is the key to effectively pursuing the long-term returns associated with size, value, and profitability.
Part of this article used with permission of Dimensional Fund Advisors.
Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. S&P and Dow Jones data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved. ICE BofAML index data © 2019 ICE Data Indices, LLC. Bloomberg Barclays data provided by Bloomberg. 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. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. There is no guarantee an investing strategy will be successful. Diversification does not eliminate the risk of market loss.
Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks, such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Sector-specific investments can also increase these risks.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
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