Expert knowledge combining financial science with real world applications.

Excess Return Premium Over the Past 80 Years

August 15, 2015

One of the main goals of the firm is to “rise above the noise” of Wall Street. At its core, Versatile Capital Management (VCM) is based primarily on well-established academic investment principals. One of the few truths in investment research is that nothing works all the time; however, there are investment concepts that have been extensively researched which, if followed with discipline, have proven in the past to increase the odds of success. It is about reducing the personal biases and behavioral tendencies of fear and greed that plague many investors.

The firm is offering two complimentary strategies. A relatively passive strategy, Strategic Core Global Asset Allocation, and a tactical strategy, Systematic Global Alpha. The Strategic Core Global Asset Allocation Portfolio is based on the tenants of the Efficient Market Hypothesis with a tilt toward factors demonstrated to add higher expected returns in the past. In equities the factors emphasized are small caps, low book to market or “value” stocks, and low volatility stocks. No individual securities are in the portfolio. These factors will be highlighted through low cost Exchange Traded Funds and Mutual Funds.

Small caps have had an average return premium of 3.46 over large caps over the period 1927-2014.

us yearly prem 392px

Value stocks have had an average return premium of 4.85% over the period 1927-2014.

us yearly value prem small

Both size and value have had long runs of positive 5 year moving average premiums with value exhibiting a steadier addition. Both are vulnerable to periods of underperformance.  The goal is to tilt the portfolio toward these factors over the long run to increase the odds of success based on the longevity of these premiums.

us 5yr avg sm

The other factor emphasized is low volatility stocks. Baskets of low volatility stocks have exhibited higher risk adjusted returns and are used to negate the typically higher beta of the size and value factors.

In addition, global diversification (ii) is stressed with equity allocations of approximately 66% US (exhibiting a home bias), 20% Developed Country, and 14% EM. The EM overweight is slight and is based upon the size of these economies being out of proportion to their share of the global equity market.

The fixed income component of the portfolio will stress both term and credit premiums with the duration maintained shorter than the overall market in light of the current level of interest rates and the corresponding lower level of expected returns. TIPS will play a role, albeit limited, despite the current lack of inflation. Who knows? Inflation, if it appears, can wreak havoc on an investment portfolio.

The portfolio allows customization to each client’s risk tolerance, desire for international exposure and duration. Transactions will take place to rebalance the portfolio after large market moves, to reflect a change in the client’s risk tolerance, to harvest losses, and improve the overall construct of the portfolio and factor tilts.

To sum it up the core strategy is based on the following assumptions:
1. It is hard to beat the market;
2. Most people do not beat the market due to high fees, market timing, haphazard asset allocation (iii) failure to rebalance, anchoring cost basis and other behavioral errors;
3. A broadly diversified portfolio attempting to capture the growth of the global economies will limit risk;
4. Over time a portfolio tilted towards factors that have produced higher expected returns in the past should be rewarded;
5. Discipline, rebalancing, and focusing on what you can control should limit behavioral tendencies that cause a drag on the investment portfolio.

Investing entails risk. Deviating from market cap weightings creates different risks, but the goal is to increase the odds of long term success by emphasizing the factors listed above.

The tactical strategy, Systematic Global Alpha, structures its portfolio from a relatively uncorrelated basket of low cost, liquid ETFs representing global asset classes. It is based upon the well-researched concept of momentum and other autocorrelation patterns with a modest adjustment to effect the volatility of the asset classes. The portfolio is rebalanced monthly (in segments) using the quantitative models established by VCM. The strategy offers “Aggressive” and “Moderate” options. The strategy was back tested (iv) to 1991 using the core principals in the current model.

The two offerings provide our clients with the ability to balance their assets between an advantaged core portfolio and a more active alpha4-seeking portfolio. While diversifying factors is important, the advantages of factor investing can diminish as more factors are added and mixed.

For instance, evidence suggests that blending active exposures to momentum and value at their purest level dilutes their benefit and that pure value and momentum portfolios have lower correlations than blended.
For example, see Value and Momentum Everywhere, (Asness, Moskowitz, Pedersen, 2012) where value and momentum are demonstrated to be negatively correlated both within and across asset classes.

Hopefully this provides a good basis of the strategies. I felt it was important to provide the above descriptions of the strategies to provide more clarity.


i  Exchange traded funds are sold by prospectus. Please consider the investment objectives, risks, and expenses carefully before investing. The prospectus which contains information about the investment company can be obtained from the Fund Company. Be sure to read the prospectus carefully before deciding to invest.
ii  Diversification does not protect against a loss. It is a method used to manage investment risk.
iii  Asset Allocation does not protect against a loss. It is a method used to manage risk.
iv  The results of back tests do not represent the results of actual trading using real money but were achieved by the means of retroactive application of principals of a model that was designed with the benefit of hindsight and should not be considered indicative of the skill of the advisor. The results may not reflect the impact of any material market factors that might impact the advisors use of the back-tested model if the model had the model actually been used during the period to manage client’s assets.

Investment Advisory services are offered through Versatile Capital Management, LLC, a Registered Investment Advisor.
This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.


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