Content written with Ryan Lamoureux.
Why do we get our suits tailored? They fit ok off the rack…sometimes. But, once you’ve worn a well-tailored suit, you know it makes a real difference. While the alterations may be small and subtle, they make a big difference when it comes to comfort and fit. Our experience is better. For an investment thought experiment, think of the “off the rack suit” as the broad market; we simply take what we get off the shelf with no alteration. Now think of Foster Group as the tailor and the alterations as portfolio personalizations called factor allocations.
Why does Foster Group make alterations to the market portfolio? Research shows that there are certain factors, or groups of securities with similar characteristics, that have historically outperformed the broad, untailored market. An example of these factors is the outperformance of small companies versus large companies. Another example is the outperformance of value versus growth companies.
How do we implement these factors into a client’s portfolio? Foster Group partners with fund providers who share our same evidence-based and research-driven investment philosophy. These partners give us the tools to construct a multi factor portfolio that we believe will outperform the market over the long term.
It is important to note that the premiums associated with these factors will not always outperform. There may be periods of time when all the factor premiums are negative and other times when they are all positive. Most years, it is a mix of positive and negative premiums. The chart below shows the risk premiums in rolling 5-year periods. Note the recent outperformance of small cap and underperformance of value. This is why Foster Group employs a multi-factor, diversified portfolio, instead of relying on only one factor to drive performance.
Information provided by Dimensional Fund Advisors LP.
In US dollars. Five-year rolling equity premium is computed as the five-year annualized compound return on the MSCI World ex USA Index (gross dividends) minus the five-year annualized compound return of the one-month US Treasury Bill. Five-year rolling size premium is computed as the five-year annualized compound return on the Dimensional International Small Cap Index minus the five-year annualized compound return on the MSCI World ex USA Index (gross dividends). Five-year rolling relative price premium is computed as the five-year annualized compound return on the Fama/French International Value Index minus the five-year annualized compound return on the Fama/French International Growth Index. The five-year rolling profitability premium is computed as the five-year annualized compound return on the Dimensional International High Profitability Index minus the five-year annualized compound return on the Dimensional International Low Profitability Index. Profitability is measured as operating income before depreciation and amortization minus interest expense, scaled by book. Dimensional indices use Bloomberg data. One-Month Treasury Bills is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Fama/French indices provided by Ken French. MSCI data copyright MSCI 2018, all rights reserved. Index descriptions available upon request. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. 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.
If we look all the way back from the mid 1920’s through 2018, we can observe that the value factor premium was positive in 62% of those years and that the small company factor premium was positive 55% of those years. If we look at that same time frame in 10 year rolling time periods, the factor premiums outperform 83% and 72% of the time respectively.
It is important to note that, even though we have a strong conviction related to these factors, we do set limits regarding how much exposure to take in any individual factor. For example, as of December 31, 2018, about 9% of the global stock market was defined as small company stocks. In Foster Group’s portfolio, small company stocks made up about 24% of the portfolio or a little more than 2.5 times the market. The same is true for the value premium. As of December 31, 2018, Foster Group portfolios held about 1.5 times the market neutral weight.
While these changes are small, they can make a big difference, just like a finely tailored suit. At Foster Group, truly caring for our clients means taking the time to learn what’s in their hearts and minds and then using proven methods to help them pursue their goals.
Foster Group is registered as an investment adviser and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability.
Charts and market returns discussed do not represent the performance of the Foster Group or any of its advisory clients. There are no assurances that an investor’s portfolio will match or outperform any particular benchmark. All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses.