Last quarter was tough for all investors, but particularly for evidence-based strategies. Share markets were down, and the shares most affected were small companies and value companies. All available evidence points to these companies having higher returns in the long run, but these exposures have done poorly in the short-term.
Share prices have bounced back, most recovering more than halfway to February's peaks. Small and value companies, on average, have bounced back more than their respective opposites.
It is natural to question what strategies we use during a period like this, no matter how short that period may be. I wanted to share a video from David Booth, founder of Dimensional Fund Advisors, where he briefly discusses his own point of view.
David Booth on Current Uncertainty
One part stood out to me, where Booth mentions:
“If you know me, you know that I’m not one to get easily talked out of my hard-earned beliefs. At Dimensional, we didn’t give up on what we knew was right when the market delivered the worst small-cap returns in history during our first nine years of business.”
Why is this important? Dimensional Fund Advisors was founded in 1981 with the goal of applying academic science to practical investing. The first fund, introduced in December that year, focused on small US stocks. Academic research had identified small company stocks as a source of higher returns, so it was a good place to start.
For small company stocks to underperform over the next nine years must have been more than disheartening. Booth, and Dimensional, persevered because they knew the strength of the evidence. Even nine years of poor performance did not disprove this.
That first fund is still running now, nearly 40 years later. It has returned 10.32% p.a. since inception, compared to 9.20% p.a. for the index.
These long periods, where small and value premiums seem to have "dried up", are a real test to investor discipline. And they occur more often than you might expect.
For five years in a row, from 1973 - 1977, the shares of highly profitable US companies underperformed their less profitable counterparts, despite evidence suggesting profitable company shares outperform long-term. Over the full period of 56 years, from 1964 - 2019, profitable companies outperformed by 3.57% p.a.
Australian shares saw a seven period, from 1985 - 1991, where small company shares underperformed large company shares in each year. Over the full period of 46 years, small company shares outperformed by 1.91% p.a.
From 2007 - 2011, US value shares underperformed growth shares for each of the five years. For the full 92 year period, value shares outperformed by 3.18% p.a.
While Booth describes his confidence as coming from a belief in markets, I believe it comes from his deep understanding of how markets work. During periods of uncertainty, continuing to rely on evidence is what led to his success, and the success of Dimensional Fund Advisors.
When markets are volatile, David Booth's perspective is vital. We can't control what the markets are doing, but we can control how we react. Continuing to focus on the evidence will help keep us on track.
