27 Sep Why value and small-cap allocation?
Our key ethos at Tandem is to construct our client portfolios based on academic evidence of what drives returns in the capital markets. Unlike many others in the financial industry, we don’t follow the flavour of the month. We don’t react to the day-to-day movement of stock prices. Instead, we rely on extensive, robust, academic evidence about how best to capture long-term returns.
The key drivers of return are well documented in different global markets and across different time periods. When we built our portfolios, we incorporated important findings based on the works of the Nobel Memorial Prize in Economic Sciences winner Gene Fama and his colleague Ken French of Dimensional. Their research shows that, over the long term:
- Smaller companies have higher expected returns than larger companies
- Value companies have higher expected returns and outperform growth companies
The chart below shows the investment of £1 in various types of investment between 1956 and 2016.
The graph is for illustrative purposes only, figures presented are hypothetical and not indicative of any investment. Past performance is no guarantee of future results. In pound sterling. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
This chart clearly demonstrates that over the longer term, smaller companies and value companies tend to outperform the overall stock market. This is not unique to the UK. A similar trend has been documented in the US, European and global equity markets. Given these findings, we built our TRAILS™ portfolios to capture the premium offered by small and value companies. Unlike conventional approaches, the strategies we use don’t hold securities in their market-value proportions. We increase the relative portfolio allocation to value and smaller companies with higher expected returns. In English, this means our higher risk portfolios hold a greater proportion of small cap and value stocks.
It is important to note that in no way do this suggest that value and smaller companies will give excess returns every year, or that they are guaranteed. Value and smaller companies funds sometimes underperform for short periods relative to the overall market. However, academic evidence suggests that this is a price worth paying over the longer term.