The Secrets of Equity Investing

clip_image002By  Donald L. Haisman, CFP®

What a great title for an article! I wish I had thought it up. In fact, it is the title of a piece from the Wall Street Journal network of blogs.1

But it’s a great article, and true. The secrets of equity investing that it references are actually open secrets. Here are some excerpts:

History shows there are three clearcut strategies that generate equity outperformance.

Buy small caps in preference to large caps. Buy shares with relatively high book-to-market valuations. And buy stocks that have been going up. What’s more, these rules hold for most markets most of the time.

That’s the conclusion drawn from the latest insta[l]lment of a sourcebook on global investment returns, running back to 1900 and covering 19 developed country markets, produced by London Business School academics Elroy Dimson, Paul Marsh and Mike Staunton for Credit Suisse.

The article takes a closer look at that third strategy buying securities that have been going up, a phrase describing what is known as relative strength. This is the basic strategy Haisman Wealth Management, Inc. uses for selecting the majority of securities for your portfolio.

And finally, there’s momentum. For the U.S., the average annual difference between buying stocks that had performed well during the previous six months and [those that] had done poorly over the same period and then holding them for a six-month period, with one month in-between (a fairly standard strategy), would have generated an excess return of 8.4 percentage points a year since 1926. Pursuing such a strategy would have made a buyer of winners about 500 times better off than a buyer of losers by 2011.

One other piece of good news was that relative strength worked even better in other developed markets. Keep in mind that with compounding over time, an 8.4% percentage point edge expands very rapidly.

So there you have it. According to the London Business School, over long periods of time in the U.S. market there has been a 2.6% advantage to small company securities, a 3.6% advantage to value-based securities, and an 8.4% advantage to high relative strength securities.

The blog author, Alen Mattich, makes a very obvious observation, which bears discussion:

…if the same investor were happy to leave these strategies to a black box, returning to it only, say, every five or maybe 10 years, said investor would likely prove to grow very rich indeed. If only such an investor existed.

As the author so abundantly makes clear, the problem is not that strategies that outperform are not available; the problem is 1) lack of systematic use of those strategies, and 2) investor impatience for short-term results. Does such an investor exist? I don’t know. If there is such an investor, they are likely to be quite interested in our Capital Allocation System accounts, like yours, which makes systematic use of relative strength (momentum) in domestic markets, international markets, fixed income and global asset classes. An investor that can exercise some patience for five or ten years is likely to be well-rewarded.

1 The Wall Street Journal, The Source, The Secrets of Equity Investing, Alen Mattich, February 7, 2011

Of course, it is not the intent of Haisman Wealth Management, Inc. to state, indicate or imply in any manner whatsoever that any investment or investment strategy can guarantee profitable results in the future or equal past performance.

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