Money: Small and value shares under-perform
10 Jul 2019
Small and value company shares have under-performed over the year to 31 March 2019 quite dramatically.
Small companies tend to out-perform large companies and value companies tend to out-perform growth companies as groups over time. This is one of the tenants of our investment philosophy and it is backed up by screeds of independent research. Not so for the year to 31 March just gone.
Small companies are easy to understand but what are value companies? Value companies are the opposite of growth companies. They aren’t growing that fast. They are probably paying out good dividends, are mature and are cheap to buy compared to their assets. An example in New Zealand of a value company is Metlifecare Limited. It’s share price is 10 times it’s profit per share and an investor only pays $0.63 for every dollar of underlying company assets when they buy a share in the company. Cheap! I hear you say. Metlifecare has 20 retirement villages throughout New Zealand with around 5,000 people living in their villages. An over-weight to Metlifecare is a part of the tilt we have to value companies in our New Zealand portfolio.
In the gobble-gook speak we use we refer to the ‘value premium’ meaning the amount that value companies outperform growth companies as a group.
For the year to 31 March 2019 the value premium for international shares was -2.6%. That is, it wasn’t a premium at all. Growth companies out-performed value by 2.6% for the year.
On top of that, truly a perfect storm, the small company premium was -5.8%. Large companies out-performed small companies by nearly 6%.
As an example, in New Zealand the Top 10 largest companies index returned 19.8% for the year while the small company index returned -1.7%.
Our portfolios have a wide range of large and small companies, value and growth companies but we have a permanent tilt towards small and value and for the last year it meant our portfolios were 5% or even 6% behind some of our competitors.
Is this degree of under-performance normal or expected? Yes, it can be. It is an example of the extra risk we take by incorporating small and value companies. Small companies are more risky than large companies and that is why they out-perform on average over the long term. Same with value companies. More return = more risk. The past year was an example of the risk side of the equation.
When are we likely to get that under-performance back? When will those small and value premiums return?
We can only understand life looking backwards but we must live life looking forwards. No-one knows when the small and value premiums will reappear. They weren’t there in May. Perhaps they were in June just gone. I don’t know yet. But I am not waiting or watching. They will come when they are ready and there is nothing anyone can do about it. “Hurry up” is not a command Mr Market responds to.
One thing we shouldn’t do is change our strategy or withdraw our money from our investments at times like these. Try and only withdraw money when the portfolio is going well, building up your emergency reserves of cash in anticipation for times when things are not going so well.
The only strategy available to us is to be patient and wait for the cycle to return. Small and value isn’t expected to pay off every year, but it is expected to pay off over time.
I remember writing an article a couple of years back describing the opposite of what we have just experienced, a huge small and value premium had just unfolded. It was 2016 and the previous year had produced a value premium in Australia of +32% and a small cap premium of 2.8%. In Australia the historic long-term premium for owning value companies is around +6.6% per annum compared to growth companies. 2016 was a great year for the value premium in Australia.
The historic small premium for international shares (excluding the US) is around 5.5% per annum and the historic value premium is also around 5.5%. In the US they have smaller historic premiums, more like 4.7% for value and 4% for small companies.
To get to those small and value premiums we must sail through the ups and downs and not let the occasional humiliation wound us so much that we lose sight of the end goal.
Patience is vital.
Keep asking great questions …
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