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Which strategy would you prefer?

April 17, 2019

Which strategy would you prefer? Obviously, anyone looking at the graph below would choose “Factors” as it outperformed the S&P 500 by 380% from the period of January 1996 through December 2018. An easy choice, right? But Factors are not the option most people choose.


There are two main reasons for this poor choice. First, when choosing to go the low-cost index approach most people opt to buy Cap-Weighted indices like the S&P 500. The financial press steers people that way, and quite frankly, by implementing a traditional low-cost Cap-Weighted index approach you will do better than most investors. Studies find an “Active” approach, either in mutual funds or individual stocks, typically lags the markets. The second reason why people may be reluctant is due to the tracking error between the Factor approach and the Cap-Weighted approach. Since the mid 90’s, the Factor portfolio has outperformed the Cap-Weighted portfolio in only 12 of 23 years. The worst period was 1998 and 1999, the peak of the Tech Bubble, when the S&P 500 outperformed the Factor portfolio by a significant amount, 55% to 27%. However, that set up an out-performance by the Factor portfolio by a whopping 72%; 66% to -6%, for the period from 2000 to 2005.


Often, underperformance over several consecutive years can cause one to question the Factors approach, but a look at history suggests that periods of underperformance are common. Taking a longer view, looking at both the Small Cap and the Value Factors (these Factors have longer historical data histories) each show outperformance between 70% and 80% over rolling 10-year periods dating back to 1950. 

Negative return differences versus the Cap-Weighted indices exist at times, sometimes trailing for long periods, e.g. the Tech Bubble. If this approach always worked, it would be easy – everyone would be doing it! But the heavily vetted concepts of Value, cheap beats expensive; Small Size, small beats big; Low Volatility, low beta stocks beat high beta; and Momentum, stocks trending in a direction continue; when applied in a diversified manner across a portfolio, have demonstrated the ability to provide higher investment returns over the long haul than comparable Cap-Weighted indices. 

Versatile Capital applies a disciplined approach to constructing Factor-based portfolios across Global Equity Markets. Over the long term this approach should increase the odds of you meeting your investment goals. But it takes patience, both to earn the overall equity premium by staying in the market through volatile markets, and to earn the higher expected returns of the Factors while living through intermittent periods of underperformance.

Past performance does not guarantee future performance.

The Factor portfolio represented in this article is rebalanced annually with an equal weight exposure. Using an equal weight methodology is a reasonable way to demonstrate the exposure to the factors, however there is uncertainty as to how Versatile would have weighted the factors. Additionally, the portfolio is comprised of the underlying factor indices. The indices do not account for any fees, commissions or other expenses that could be occurred. The source of the data for the underlying indices was Morningstar.

Versatile Capital Management is a registered investment advisor with the State of Illinois. The firm will only transact business in states where it is properly registered and in compliance with the applicable laws and securities regulations.

The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weightedindex with each stock's weight in the index proportionate to its market value.

Investing entails some degree of risk. Investors should inform themselves of the risks involved before engaging in any investment.

Before commencing an investment program, we recommend you seek independent professional legal, tax and investment advice as to whether it is suitable for your particular needs and circumstances. Failure to seek detailed professional personally tailored advice prior to acting could lead to you acting contrary to your own best interests and could lead to losses of capital.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

Neither this presentation nor any accompanying materials constitute an offer to sell, nor a solicitation of an offer to buy, securities, nor may this presentation nor accompanying materials be relied upon in reviewing future offerings to be made.

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