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The Science of Investing
- 1. 5000.1 The Science of Investing Duncan Orr Swindells Financial Planning
- 2. Can I, or somebody I know, reliably predict enough superior performing investments, in advance, that will create excess return above the market, after costs, for my clients?
- 5. Focus on the dimensions of risk that deliver higher expected returns over the longer term
- 6. Maintain discipline and a commitment to a long term investment strategy, avoiding attempts to market time
- 9. Equity Returns of Developed Markets Annual Return (%) In British Pounds Highest Return Lowest Return Source: MSCI developed markets country indices (net dividends) with at least twenty-five years of data. MSCI data copyright MSCI 2009, all rights reserved. This material has been distributed by Dimensional Fund Advisors Ltd., which is authorised and regulated by the Financial Services Authority. Past performance is no guarantee of future results.
- 11. Understanding Stock market performanceThe Value and Small cap premiums
- 13. Size and Value Effects Are Strong around the WorldAnnual Index DataPercent per Annum in £ Annualised Compound Returns (%) Standard Deviation (%) Value stocks are above the 30th percentile in book-to-market ratio. Growth stocks are below the 70th percentile in book-to-market ratio. Simulations are free-float weighted both within each country and across all countries. UK and Europe data provided by London Business School/StyleResearch. US value and growth data provided by Fama/French. This material has been distributed by Dimensional Fund Advisors Ltd., which is authorised and regulated by the Financial Services Authority. Past performance is no guarantee of future results.
- 14. UK Value vs. UK Market Monthly: July 1955-December 2009 5340.3 Percentage of All Rolling Periods Where UK Value Outperformed UK Market Source: UK Market is the FTSE All-Share Index. FTSE data published with the permission of FTSE. UK Value simulated by Dimensional from Bloomberg securities data, prior to 1994 data provided by London Business School. This material has been distributed by Dimensional Fund Advisors Ltd which is authorised and regulated by the Financial Services Authority. Past performance is no guarantee of future results.
- 15. UK Small vs. UK Market Monthly: March 1955-December 2009 Percentage of All Rolling Periods Where UK Small Outperformed UK Market Source: UK Small simulated by Dimensional from StyleResearch securities data; prior to July 1981, Hoare Govett Smaller Companies Index, provided by the London School of Business. UK Market is the FTSE All-Share Index. FTSE data published with the permission of FTSE. This material has been distributed by Dimensional Fund Advisors Ltd., which is authorised and regulated by the Financial Services Authority. Past performance is no guarantee of future results.
- 17. Over longer time periods, the size and value premiums are more prevalent.
- 18. Investors that maintained disciplined size and value exposure were ultimately rewarded.2009 Size Premium Percent per Year 2009 Our source of share price and listing information was the London Share Price Database (LSPD) maintained at the London Business School. The master index of this database covers all listed stocks in the UK market since 1957. We selected stocks officially listed on the LSE and excluded foreign companies and investment trusts. To choose the value sectors we rank the universe by book-to-market and approximately the top 30% is the value universe. The small sectors we rank the universe by market capitalisation and approximately the bottom 10% is the small universe.Copyright © 2003 Elroy Dimson, Stefan Nagel and Garrett Quigley. UK research data provided by the London School of Business.
- 20. Market timing involves knowing when to buy, when to sell and when to buy again
- 24. Over long time periods, high management fees and related expenses can be a significant drag on wealth creation.
- 25. Passive investments generally maintain lower fees than the average actively managed investment by minimising trading costs and eliminating the costs of researching stocks.£5,000,000 2% Fee £4,000,000 £3,745,318 3% Fee British Pounds £3,000,000 £2,806,794 £2,000,000 £1,000,000 1 Year 3 Years 5 Years 10 Years 20 Years 30 Years Time For illustrative purposes only.
- 26. The role of Fixed Interest investments within a portfolio
- 30. Historically, longer maturity instruments have higher standard deviations and have not provided consistently greater returns.Return (%) US Equities UK Equities 10 UK Bonds UK Bills US Bonds 5 US Bills 0 10 15 20 5 25 Standard Deviation (%) Dimson, Elroy, Paul Marsh, and Mike Staunton. Millennium Book II: 101 Years of Investment Returns. ABN AMRO and London Business School, 2001. This publication defines the data used for the above chart and matrix as follows: UK Bills are UK One-Month Treasury Bills (FTSE). UK Bonds are the ABN AMRO Bond Index. UK Equities are the ABN AMRO/LBS Equity Index. US Bills are commercial bills 1900-1918 and One-Month US Treasury Bills (Ibbotson) 1919-2000. US Bonds are government bonds 1900-1918, the Federal Reserve Bond Index 10-15 Years 1919-1925, Long-Term Government Bonds (Ibbotson) 1926-1998, and the JP Morgan US Government Bond Index 1999-2000. US Equities are Schwert’s Index Series 1900-1925, CRSP 1-10 Deciles Index 1926-1970, and the Dow Jones Wilshire 5000 Index 1971-2000.
Editor's Notes
- This cartogram depicts the world not according to land mass, but by the size of each country’s stock market relative to the world’s total market value (free-float adjusted). Population, gross domestic product, exports and other economic measures may influence where people invest. But the map offers a different way to view the universe of equity investment opportunities. If markets are efficient, global capital will migrate to destinations offering the most attractive expected returns. Therefore, the relative size and growth of markets may help assess the political, economic and financial forces at work in countries. The cartogram vividly illustrates the importance of global diversification and the need for investors to avoid over-allocating capital to their home country’s stock market. Those who maintain a “home market bias” are closing their portfolios to a large share of the investment universe. Of course, the investment world is in motion, and these proportions will change over time as capital flows to markets offering the most attractive returns.
- Talking Points:The size and BtM effects appear in both UK and international markets—strong evidence that the risk factors are systematic across the globe.This graph demonstrates the higher expected returns offered by small cap stocks and value (high BtM) stocks in the UK, Europe ex UK, US, and emerging markets. Note that the international and emerging markets data is for a shorter time frame.Small cap stocks are considered riskier than large cap stocks, and value stocks (as defined by a higher book-to-market ratio) are deemed riskier than growth stocks. These higher returns reflect compensation for bearing higher risk. A multifactor approach incorporates both size and value measures—and exposure to non-UK markets—in an effort to increase expected returns and reduce portfolio volatility. An effective way to capture these effects is through portfolio structure.
- The following three slides underscore the importance of maintaining a long-term perspective in a structured portfolio and committing to one’s asset allocation.This slide documents that the value effect grows stronger over longer holding periods. The chart calculates the frequency that value stocks have outperformed the overall market since 1955. This performance is calculated according to rolling time periods—from one year to forty years.The bars in each column indicate the percentage of the time that the UK Value stocks outperformed the UK Market for each rolling period. For example, there were 643 one-year periods (e.g., July 1955 through June 1956), 535 ten-year periods, and 415 twenty-year periods, and 175 forty-year periods. In these holding periods, value outperformed the UK Market 70%, 99%, 100%, and 100% of the time, respectively.Although value stocks have higher expected returns than growth stocks, investors should recognise that the record of realised returns does not assure a similar pattern in the future. The timing and magnitude of the value premium will always be uncertain.
- Talking Points:The size effect also proves itself over longer holding periods. The chart applies the same format to illustrate that risk factor compensation is also working in the small cap arena.The bars in each column indicate the percentage of the time that the UK Small stocks outperformed the UK Market for each rolling period. For example, between March 1955 and December 2009, there were 647 one-year holding periods, 479 fifteen-year periods, and 179 forty-year periods. In these holding periods, small cap stocks outperformed the UK Market 66%, 78%, and 100% of the time, respectively.Although small company stocks have higher expected returns than large company stocks, investors should recognise that the record of realised returns does not assure a similar pattern in the future. The timing and magnitude of the size premium will always be uncertain.
- Talking Points:The harsh reality of market efficiency has not stopped speculators and other traders from attempting to read the future. On paper, market timing offers a seductive prospect: By predicting market direction ahead of time, a trader might capture only the best-performing days and avoid the worst. This slide tells the other side of that story. Large gains may come in quick, unpredictable surges. A trader who misinterprets events may leave the market at the wrong time. Missing only a small fraction of days—especially the best days—can defeat a timer’s strategy.For example, over a twenty-four-year period (1986-2009), missing the best twenty-five trading days would have cut FTSE All-Share Index annualised compound return from 10.00% to 4.41%.Trying to forecast which days or weeks will yield good or bad returns is a guessing game that can prove costly for investors.
- Talking Points: The graph shows that longer-term UK bonds offer higher expected returns than one-year UK bills. But the return difference is not large, especially when compared to the return premium offered by UK and US stocks. From a portfolio perspective, the higher standard deviation of UK bonds is not worth taking. This suggests a move from long-term bonds to UK bills, which offer higher credit quality and a shorter maturity. The lesson is that holding long-term fixed interest in a portfolio may not pay for itself in terms of expected reward for the high level of risk assumed.