Expected Sources of Premium Stock Returns Part II: How Much Risk? How Much Expected Return?

January 27, 2016  |  

Expected Sources of Premium Stock Returns Part II: How Much Risk? How Much Expected Return?

In our last post, we introduced three major sources of return in the global stock markets, and how we went about identifying them. This raises another question: How have they been doing so far?

A Look at the Evidence

Before we determine that it’s a new world, in which we should jettison decades of data about expected market premiums, take a look at the long-term evidence. We’ll use U.S. data here, although international investments would likely tell a similar tale.

dimensions

As shown in Figure 1, from 1928–2014, “the market” (U.S. stocks) has delivered an average annual return premium of just over 8 percent more than “risk-free holdings” (one-month U.S. Treasury Bills). Also on annual average, small-cap stocks have outperformed large-cap by about 3.5 percent, and value stocks have outperformed growth by about 5 percent.

So far, so good; the long-term data indicates that investors can expect premium returns by tilting their portfolios toward small-cap and value stocks.

But what if the party is over? What if these premiums have somehow disappeared? While this is not impossible, there’s good data to support our belief that small-company and value stock premiums are alive and well (if slumbering). In our next post, we’ll take a look at that evidence.

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About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES

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