Ian Lance, co-Head of the UK Value & Income Team at Redwheel and co-fund manager of Temple Bar Investment Trust is a self-professed investment geek as he is as excited about the release of the annual Credit Suisse Investment Returns Handbook as others are about a new season of Love Island.
Now in its 15th year and established as one of the definitive sources for the analysis of the long-term performance of global financial assets, Ian’s favourite section is on Style Investing, which is a very long-term study of what works in investing and each year builds on the same three conclusions about which factors produce excess returns: size, value and momentum.
Size
The study shows that in the US stock market, between 1926-2022, the returns on large-cap stocks were an annualised 9.6% while small-and microcap stocks achieved 11.8% and 12.4% respectively. This meant a dollar invested in 1926 in larger companies, with dividends reinvested, grew to $7001; in small caps to $49,842, and micro-cap stocks doing best of all with an end 2022 value of $80,567.
The evidence from the UK, although covering a shorter period from 1955, reaches a similar conclusion with a pound in UK large caps accruing to £1255; £3671 if invested in the Numis Mid Cap Index and £8326 in the Numis Small Cap Index. However, an investment in micro caps would have yielded £35,793
Value (price to book)
As value investors, Ian is most encouraged by the finding that value investing earns a significant premium in the long run. In the US, $1 invested in the cheapest part of the market in 1926 was worth $97,919 by the end of 2022, whilst a dollar invested in the most expensive part of the market was only worth $6580
Value (High Dividend Yield)
As well as looking at returns using price to book, the authors also use dividend yield as a measure of valuation and derive similar results.
Momentum
Of all the factors identified, the authors describe momentum as the ‘premier anomaly’.
Conclusion
In Ian’s experience, it is common to find investors with a sizeable allocation to large cap and growth (the factors shown to produce returns less than the market) than small cap and value. Despite these factors producing disappointing returns in 2022, assets continued to pour into growth firms such as ARK Invest last year.
So, what explains this seemingly irrational behaviour?
(i) The problem with very long-term data is it doesn’t reveal the concentration risk (is the cheapest part of the market all in one sector?) nor the volatility of returns (small caps in the US performed poorly during The Great Depression and did not catch up with large caps until the early 1940s and the 1990s was also a fallow period for small cap stocks).
(ii) Some of the strategies may be easier to implement in theory than in practice.
(iii) The result of several behavioural traits influencing investor behaviour: recency bias; group think or herding; over optimism and over confidence.
Using strategies employing factors which have historically been shown to be successful is a way of tilting the odds of success in your favour. Betting on factors that have a long history of producing poor returns but have worked recently is not a strategy likely to be successful in the long run.
