Gregg Fisher is waiting for the stock market to right itself after a decade of standing on its head.
As of fall, Fisher notes that the equity market has endured 10 straight years where large-cap growth, meaning larger and more expensive companies, tended to outperform small-cap value, or smaller and less-pricey businesses.
In a recent paper, Fisher, founder and head of quantitative research and portfolio strategy at New York-based Gerstein Fisher, asks why the small and value factors, which in the past have offered investors enhanced equity returns, seem to have lost their effectiveness, and wonders if they will ever return to their benchmark-beating ways.
“[Size and value] are arguably the two most important, longest-standing and heavily researched investing factors,” says Fisher. “It’s been a good 10 years for these companies that are huge and super expensive, but maybe that alone is reason to consider exposures to things that haven’t gone up that much.”
Value investing, originally conceived by Ben Graham and David Dodd as careful financial analysis that precedes an investment decision, still cleaves to the principle that higher returns can be generated through investing in stocks with lower valuations. Today, investors of all stripes can access at least some of the value premium by purchasing passive funds based on the cheapest segment of stocks selected from a benchmark index like the Russell 1000 or the S&P 500.
Small-cap investing, as described in the 1980s, links higher returns to the size of the company, with lower market capitzliation companies historically offering higher returns.
Fisher found that from 1927 to the end of September, small-cap value stocks have outperformed large-cap growth stocks by an annualized 5 percent or more. As investors are exposed to higher concentrations of smaller or less valuable stocks, their historical returns increase incrementally.
Since 2007, large-cap growth investing has outperformed small-cap value investing by nearly 3 percent per year, and both small-cap and value investing strategies have tended to lag core indexes like the S&P 500, says Fisher.
Fisher wonders if the last 10 years represents an aberration rather than a long-term trend, noting that 10-year investment periods tend to be idiosyncratic and not necessarily indicative of future market performance. Even 20-year investment periods can be idiosyncratic, says Fisher, who noted that in February 2009, the equity market premium, or the performance associated with investing in stocks versus low-risk bonds, had turned negative for the trailing 20 years, meaning the risk-free rate of return exceeded the returns provided by equity markets between February 1989 and February 2009.
“For the past 20 years, there had been no reward for risk. That happened to be a moment where bonds did better than stocks and the risk premium on equities was at its most negative point ever,” says Fisher. “As it turns out, that would have been the worst period of time ever to have gotten out of the stock market. I would say we’re in a similar period of time for value versus growth or small versus big.”