Looking for action? Try large-cap value stocks
Reprinted courtesy of MarketWatch.com.
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Investors looking for a bit more “action” than they’ll find in the Standard & Poor’s 500 Index and other large-cap-blend funds don’t have to look very far.
U.S. large-cap value stocks, a distinct asset class that has been tracked for nearly 90 years, provide “action” in both directions. They have produced significantly higher returns in some periods and significantly greater losses in others.
But on balance, value stocks are a good long-term bet for part of an equity portfolio. As you probably know, what sets value stocks apart is that they are out of favor with investors.
That means there’s less demand for value stocks. Less demand means lower prices. Lower prices can mean bargain prices. Value stocks let investors do what they know they should be doing: Buying low as in the old saw: “Buy low, sell high.”
In this article I’ll walk you through the performance of this asset class for the past 87 calendar years — 1928 through 2014.
We’ll see how large-cap value’s DWLV, +0.05% performance differs from that of the S&P 500 index SPX, +0.03% . We’ll see what various 40-year periods look like, something that will interest young investors. And we’ll look at 15-year periods, which should be relevant to most investors, including retirees.
Starting with the long view, the 87-year compound return from 1928 through 2014 was 11.2%, enough to turn a one-time investment of $100 into $1,104,778.
(The S&P 500, by comparison, returned 9.8%; $100 would have grown to $346,261. There’s a striking lesson in the huge difference an extra 1.2 percentage points of return can make if given enough time.)
Over that period, large-cap value stocks had 65 profitable years, with gains averaging 23.8%. In the 22 losing years, the average loss was 15.5%.
As with the S&P 500 there is good and bad news. The good is very good: There were three times as many profitable years as losing ones, and the good years averaged very robust returns. In its best year, 1933, this asset class was up a whopping 92.7%.
But the bad news is strikingly bad. In addition to 22 years with average losses in double digits, in 1931, large-cap value stocks were down 62%. That was more than 80 years ago, but it shows what can happen.
This asset class is more volatile than the S&P 500. In 1931 the S&P lost “only” 43.3%; in 1933, that index was up “only” 54%.
For another indicator of this volatility, there were 11 years in which large-cap value stocks were either up or down more than 40% — compared with only six such years for the S&P 500.
I wasn’t surprised (and you should not be surprised either) to find that the volatility declined significantly when tracking performance in increments of 15 years instead of just one year.
The best 15-year period ended in 1989 with a compounded return of 21.7%. The worst, from 1928 through 1942, ended up with a compound loss of 1.4%.
(The average return of all 15-year periods was 13.2%, compared with 10.7% for the S&P 500.)
Investors can’t pick the good periods in advance, but those who got into large-cap value stocks (and held on for at least 15 years) any time from 1961 to 1992 were lucky (and probably thought they were very smart). In those 33 periods, large-cap value stocks had an average compound return of 15.3%, and each period was more than 10%.
Young investors (if they’re smart) will be more interested in how this asset class did over periods of 40 years. And in this case, the news is quite good. The average compound return of all 48 periods for this asset class was 13.5%.
In real life, of course, you don’t get average returns; you get the return of the period in which you actually invest money.
If you had to accept a 40-year historical period at random, the very worst case was from 1930 through 1969, which provided a compound return of 8.3%. If you were exceptionally lucky, you invested from 1958 through 1997 and achieved a compound return of 15.7%.
Fortunately, 40-year investors had a very high probability of lucking out in large-cap value stocks. In more than 90% of the cases, the compound return was above 10%.
I’ve thrown out a lot of numbers, and there are a few words of fine print that should go with them. These returns are hypothetical and couldn’t have been achieved exactly because of inevitable taxes, fees and other costs.
The same is true of all the asset classes I’m discussing in this series of articles.
Data for my calculations comes from Dimensional Fund Advisors, which calculates indexes and runs a series of asset-class funds. The data goes back much farther in time than the track record of Dimensional funds.
But here’s an interesting comparison: For the 15 years ended in 2014, the hypothetical compound return based on the company’s database was 8.1%. Yet the actual compound return, after fees, of the Dimensional large-cap value fund was 8.4%. This improvement didn’t result from stock-picking but from many instances of fine-tuning for which Dimensional is known. (I will discuss that fine-tuning in a future article.)
It’s clear from this 87-year history that value stocks have something valuable to add to the S&P 500 Index. Their added value comes with higher volatility, but long-term investors who can stay the course have been rewarded well.
This underscores one of my complaints about Vanguard’s Total Stock Market Index Fund US:VTSMX , which has only about 36% of is portfolio in value stocks. (More than 60% of my recommended equity portfolio is made up of value stocks.)
The allure of value investing doesn’t stop with large-cap stocks. In a future article I’ll show how small-cap value stocks have done even more for patient investors who can stand their volatility. And value works in foreign markets, too, as we shall see.
For more on this topic, check out my podcast, 10 things you should know about large-cap value.
Richard Buck contributed to this article.