In fact at that point in July large growth stocks had returned over 19% per year since 2017 while small value stocks had lost 7.2% per year. This was the widest margin ever recorded over such a period of time for the two asset classes. My message at the time was for small value investors to hold strong, as periods of significant underperformance are rare but expected. And for those who currently had no allocation to small cap value, they may want to consider it based on the long-term theory and data. I’d encourage readers to review the original article.
Since July 21st small cap value stocks have come roaring back and have outperformed by a wide margin. Using ETF’s as a proxy, the Vanguard S&P Small-Cap 600 Value ETF (VIOV) has outperformed the Vanguard Growth ETF (VUG) by approximately 45% with VIOV up 62% and VUG up 17%. Other small value ETFs have done even better such as the Avantis U.S. Small Cap Value ETF (AVUV), up nearly 72%.
Over the long-term there are differences in expected returns across stocks. For example, I expect:
- Small cap stocks to outperform large cap stocks
- Value stocks to outperform growth stocks
- Stocks with high profitability to outperform stocks with low profitability
All of these relationships can be used to construct a portfolio with higher expected returns than the market with only a few mutual funds or ETF’s. The weights given to small cap, value, and high profitability stocks can be customized to each individual’s risk preferences similar to the decision of how much to allocate to stocks vs. bonds. By overweighting stocks with higher expected returns and underweighting stocks with lower expected returns, an investor can maintain the benefits of indexing such as broad diversification, low turnover, and low expenses.
One of the best attributes of this approach to beating the market is that it doesn’t require active trading or market timing. Occasionally rebalancing the portfolio back to pre-established weights is the only recommended maintenance. This can be done with software or an excel spreadsheet. I believe an investor who manages their portfolio in this manner is likely to beat the majority of other individual and professional investors over an investing lifetime.
Academic theory and long-term historical data highlights how small value stocks have higher expected returns than large growth stocks, and there are some good fund options available today to take advantage of this belief. Of course, these relationships don’t always materialize over shorter periods of time otherwise there would be no risk. But the recent resurgence of small value stocks since my July post highlights how quickly trends in performance can change.
So, what should you do? If you missed my July post and still have little or no exposure to this category of the market, now may still be a good time to consider adding more weight in your portfolio to funds that buy small cap value stocks with robust profitability. If you already have greater than market cap weighted exposure to small cap value like I do, it’s probably time to check your portfolio because the spread in recent performance may require you to rebalance back to your target allocation.
Back in July this would have involved trimming large growth exposure and using the proceeds to add to small value, but today this would likely be the opposite. You should only consider changing your portfolio to include more small cap and value exposure if you’re willing to stick with it for the long run knowing that expected returns are not guaranteed over any specific time horizon.
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University.