It is our goal to continuously target the dimensions of higher expected returns. Fama and French proposed a five-factor model that combined the equity risk factors from the three-factor model (market, size, and relative price) with the two risk factors that influence fixed income returns (maturity and credit quality) and later introduced profitability as an additional dimension of higher expected returns in equities.
The numbers below provide historical premiums from the asset classes mentioned in the Fama and French model.
All premiums and returns annualized(1)
US Stocks
From 1928 to 2018
Small companies return 11.86%, Large companies return 9.71%. Small minus Large 2.16% premium
Value companies return 12.41%, Growth companies return 9.11%. Value minus Growth 3.30% premium
From 1964 to 2018
High relative profitability return 12.12%, Low relative profitability return 8.15%. High minus Low 3.98% premium
Developed Markets
From 1970 to 2018
Small companies return 13.93%, Large companies return 9.08%. Small minus Large 4.85% premium
From 1975 to 2018
Value companies return 13.23%, Growth companies return 8.22%. Value minus Growth 5.01% premium
From 1990 to 2018
High Profitability companies return 6.03%. Low profitability companies return 1.89%. High minus Low 4.14% premium
Emerging Markets
From 1989 to 2018
Small companies return 11.41%. Large companies return 9.54%. Small minus Large 1.87% premium
Value companies return 12.77%. Growth companies return 9.11%. Value minus Growth 3.66% premium
From 1996 to 2018
High profitability companies 8.19%. Low profitability companies 2.58%. High minus Low 5.60% premium.
Investors receive an additional expected return premium for holding small, value and high profitability stocks in greater proportion than the market or conventional portfolios. An investor’s expected return in a diversified portfolio is determined by her/his exposure to these dimensions of higher expected returns.
The first asset allocation decision is the balance between stocks and bonds. Next, within the equity allocation we must determine how much to tilt towards small companies, value companies and high profitability companies versus the overall market. The more we tilt, the greater the probability to receive higher expected returns above the market. Within fixed income (bond portfolio) the decision involves the appropriate amount of term and credit risk to take.
Understanding the dimensions of higher expected returns gives us a framework for creating an investment strategy.
As we review one of the Dimensional Equity Balanced Strategies (2), tilted to the dimensions of higher expected returns comparing to S&P 500 index, since January 1970 to December 2018, DFA strategy had a positive difference 86.2% of the time.
The numbers below provide historical premiums from the asset classes mentioned in the Fama and French model.
All premiums and returns annualized(1)
US Stocks
From 1928 to 2018
Small companies return 11.86%, Large companies return 9.71%. Small minus Large 2.16% premium
Value companies return 12.41%, Growth companies return 9.11%. Value minus Growth 3.30% premium
From 1964 to 2018
High relative profitability return 12.12%, Low relative profitability return 8.15%. High minus Low 3.98% premium
Developed Markets
From 1970 to 2018
Small companies return 13.93%, Large companies return 9.08%. Small minus Large 4.85% premium
From 1975 to 2018
Value companies return 13.23%, Growth companies return 8.22%. Value minus Growth 5.01% premium
From 1990 to 2018
High Profitability companies return 6.03%. Low profitability companies return 1.89%. High minus Low 4.14% premium
Emerging Markets
From 1989 to 2018
Small companies return 11.41%. Large companies return 9.54%. Small minus Large 1.87% premium
Value companies return 12.77%. Growth companies return 9.11%. Value minus Growth 3.66% premium
From 1996 to 2018
High profitability companies 8.19%. Low profitability companies 2.58%. High minus Low 5.60% premium.
Investors receive an additional expected return premium for holding small, value and high profitability stocks in greater proportion than the market or conventional portfolios. An investor’s expected return in a diversified portfolio is determined by her/his exposure to these dimensions of higher expected returns.
The first asset allocation decision is the balance between stocks and bonds. Next, within the equity allocation we must determine how much to tilt towards small companies, value companies and high profitability companies versus the overall market. The more we tilt, the greater the probability to receive higher expected returns above the market. Within fixed income (bond portfolio) the decision involves the appropriate amount of term and credit risk to take.
Understanding the dimensions of higher expected returns gives us a framework for creating an investment strategy.
As we review one of the Dimensional Equity Balanced Strategies (2), tilted to the dimensions of higher expected returns comparing to S&P 500 index, since January 1970 to December 2018, DFA strategy had a positive difference 86.2% of the time.
(1) Information provided by Dimensional Fund Advisors LP.
All returns are in USD. Premiums are calculated as the difference in annualized returns between the two indices described over the period shown. MSCI indices are gross div.
For US stocks, indices are used as follows. Small Cap minus Large Cap: Dimensional US Small Cap Index minus the S&P 500 Index. Value minus Growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. High Prof minus Low Prof: Dimensional US High Profitability Index minus the Dimensional US Low Profitability Index. For developed ex US stocks, indices are used as follows. Small Cap minus Large Cap: Dimensional International Small Cap Index minus the MSCI World ex USA Index (gross div.). Value minus Growth: Fama/French International Value Index minus the Fama/French International Growth Index. High Prof minus Low Prof: Dimensional International High Profitability Index minus the Dimensional International Low Profitability Index. For Emerging Markets stocks, indices are used as follows. Small Cap minus Large Cap: Dimensional Emerging Markets Small Cap Index minus MSCI Emerging Markets Index (gross div.). Value minus Growth: Fama/French Emerging Markets Value Index minus Fama/French Emerging Markets Growth Index. High Prof minus Low Prof: Dimensional Emerging Markets High Profitability Index minus the Dimensional Emerging Markets Low Profitability Index. Profitability is measured as operating income before depreciation and amortization minus interest expense, scaled by book.
Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower. See “Index Descriptions” in the appendix for descriptions of Dimensional and Fama/French index data. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved.
(2) In US dollars. Sources: Dimensional Index data compiled by Dimensional; S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. See "Dimensional Equity Balanced Strategy Index Description" slides in the Appendix for more information. The indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
All returns are in USD. Premiums are calculated as the difference in annualized returns between the two indices described over the period shown. MSCI indices are gross div.
For US stocks, indices are used as follows. Small Cap minus Large Cap: Dimensional US Small Cap Index minus the S&P 500 Index. Value minus Growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. High Prof minus Low Prof: Dimensional US High Profitability Index minus the Dimensional US Low Profitability Index. For developed ex US stocks, indices are used as follows. Small Cap minus Large Cap: Dimensional International Small Cap Index minus the MSCI World ex USA Index (gross div.). Value minus Growth: Fama/French International Value Index minus the Fama/French International Growth Index. High Prof minus Low Prof: Dimensional International High Profitability Index minus the Dimensional International Low Profitability Index. For Emerging Markets stocks, indices are used as follows. Small Cap minus Large Cap: Dimensional Emerging Markets Small Cap Index minus MSCI Emerging Markets Index (gross div.). Value minus Growth: Fama/French Emerging Markets Value Index minus Fama/French Emerging Markets Growth Index. High Prof minus Low Prof: Dimensional Emerging Markets High Profitability Index minus the Dimensional Emerging Markets Low Profitability Index. Profitability is measured as operating income before depreciation and amortization minus interest expense, scaled by book.
Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower. See “Index Descriptions” in the appendix for descriptions of Dimensional and Fama/French index data. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved.
(2) In US dollars. Sources: Dimensional Index data compiled by Dimensional; S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. See "Dimensional Equity Balanced Strategy Index Description" slides in the Appendix for more information. The indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
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