One of the simple but powerful maxims in investing is buy low, sell high. It’s intuitive logically but difficult behaviorally. Over and over, investors — non-professional and professional alike — panic when an asset class declines and, metaphorically, ‘run for the door’. Buying into a declining asset is difficult psychologically; increasing your stake in that which is hurting you goes against your natural instinct. At Heritage, we believe a disciplined approach to investing is essential to achieving long-term investment success. In the first quarter of 2016 our clients were able to buy low and sell high.
On January 15, 2016 and January 18, 2016, Heritage increased its clients’ allocation to equities. The MSCI All Country World Index had declined nearly 20% from its prior peak on May 21, 2015. Over the first fifteen days of 2016 alone, global equities fell 8.70%. We saw this as an opportunity to buy equities low and sell bonds and alternative investments high. By the end of the first quarter, on March 31, 2016, global equities had increased from their level on January 15, 2016 by 9.79%.
Heritage’s decision to increase equities was based on empirical evidence. Over monthly-rolling annual periods from 1970 to 2015, the average global equity return is 9.68%.1 As a sub-set of those data, after 20% equity drawdowns, forward annual periods averaged a return of 13.44%. There is a return premium for buying when others are willing to sell at a discount, which extends beyond one year.
Although the increase to equity added value, our clients’ long-term positioning in equity drives the majority of portfolio risk and return. The portion of a portfolio allocated to equity is made based on a client’s risk tolerance and is the single most important factor explaining risk and return. However, within the equity allocation, at least two other decisions are important: the geographical-developed category split (United States versus developed international versus emerging markets); and the aggregated security characteristics with regard to the dimensions of return (value versus growth, small cap versus large cap, high profitability versus low profitability).
Emerging markets led global equities with a 5.71% return over the first quarter of 2016.2 United States equities returned 0.97%3 and developed international equities declined by 3.01%.4 Relative to the global equity market, Heritage’s clients are on target in the United States—a full allocation. On the other hand, Heritage’s clients are underweight developed international markets—the U.K., Japan, Australia and much of Europe—and overweight emerging markets within their international equity allocation.
For the past few years, this schema has been a headwind: emerging markets performed poorly. We have advised our clients to stay the course to reap the expected outperformance from emerging markets equity over the long term. Thus far this year, emerging markets have produced a premium return.
The dimensions of return that Heritage’s clients target produced additional value relative to broad indices. In every geographical-developed category, Heritage’s equity manager, Dimensional Fund Advisors (DFA), outperformed its benchmark.
- Global equities and the returns based thereon are calculated using the MSCI World NR USD Index as provided by Morningstar. Data are collected from January 1970 through December 31, 2015.
- Emerging markets equity is represented by, and the returns based thereon are calculated using, the MSCI EM NR USD index as provided by Morningstar.
- United States equity is represented by, and the returns based thereon are calculated using, the Russell 3000 TR index as provided by Morningstar.
- Developed International equity is represented by, and the returns based thereon are calculated using, the MSCI EAFE NR USD index as provided by Morningstar.