Owning a global equities fund allows an investor to invest in the capital markets in an easy method by providing them with a diverse basket of stocks from companies all around the world. Maybe a tracker for the worldwide market index.

Nowadays, it is easy and inexpensive to accomplish this. Take this passage from Eugene Fama, who is regarded as the founder of modern finance:

“You have to talk yourself out of the market portfolio”

Eugene Fama, speaking with The Rational Reminder Podcast, May 2020

This provides us with a reasonable foundation upon which to develop a portfolio. Nonetheless, many excellent reasons exist to talk oneself out of investing in the market portfolio. As should always be the case, a substantial body of evidence supports each of these arguments.

Many years of research indicate that groups of businesses with specific traits show distinct returns to the market overall. The various risks that are present in these categories of businesses can account for the variations in returns. ‘Small caps’, or value and smaller companies, are two examples.

There are two reasons to have exposures, or “tilts,” to these companies.

 

1. Increase expected returns

Given the increased risks associated with investing in value or small-cap stocks, it is reasonable to anticipate better long-term returns. This is by no means a guarantee, much like most things in the financial world. On the other hand, investors’ chances of realizing the long-term projected outcomes increase with the length of time they retain such portfolio exposures.

 

Figure 1: The opportunity for higher returns in value and small caps

Data source: Dimensional Returns Web. Jul-26 to May-24. Data in USD. Market: Fama/French Total US Market Research Index, Value: Fama/French US Value Research Index, Small cap: Fama/French US Small Cap Research Index

 

A portfolio with modest tilts toward small caps and value experienced an annualized excess return of 1% over the whole stock market during the same time as seen in the above figure. This is an opportunity for investors to raise their chances of making profitable investments and, eventually, reaching their financial objectives.

However, a skewed portfolio does not always produce the anticipated outperformance. Sometimes these kinds of exposures can cause an investor to underperform the market. In the short run, it might lead to more significant drops during market downturns. The US market dropped 49% and the skewed portfolio fell a further -7% at the worst of the aforementioned period, which occurred between April 37 and March 38. Long-term rewards await investors who have the endurance and perseverance to stick to their disciplined plan of purchasing, holding, and rebalancing throughout these uncertain times.

 

2. Improve diversification

Improved diversification is a key advantage of abandoning the portfolio and favouring value and smaller businesses. This is known as holding exposures to poorly correlated asset classes in the language of investing. Better “worst case” results may arise from this, which is something that every investor should be concerned about.

 

Figure 2: Worst month-to-month return outcomes over different periods

Data source: Dimensional Returns Web. Jul-26 to May-24. Data in USD and cumulative terms. Market: Fama/French Total US Market Research Index, Value: Fama/French US Value Research Index, Small cap: Fama/French US Small Cap Research Index

 

As of this writing, the top five corporations account for 17% of the global market. If you have a skewed portfolio, this drops to 10%. As the largest firms in the world, these companies allow investors to earn higher profits while reducing their concentration on a smaller number of enterprises.

 

3. Have confidence in the approach

It is reassuring for investors to know that they have a well-designed, empirically supported solution that is intended to produce superior results. For several individuals, having cash or short-term bonds also facilitates the process of investing.

Start with the market portfolio while considering an investment solution’s growth engine. It makes sense to move away from this under the direction of a strong body of data. The challenging task for an investor is to maintain confidence in their approach over time while avoiding an overemphasis on short-term results. Your adviser is always available to assist you with this.