In reviewing the performance figures for the APC Classic Portfolios (click here) you will notice that for the first time in quite some time, some portfolios have underperformed their benchmark over the 1 Year time frame though they all outperform over longer timeframes.

One year returns can vary significantly due to short term factors, so this timeframe is really just ‘noise’ when it comes to understanding an investment portfolio’s long term capacity.  However it is important to understand why this has occurred. We explore this below and the reasons behind the variance from the ‘benchmark’.

A Quick Review: ‘Our Investment Philosophy’
As you may recall, Australian Private Capital (APC) has an Investment Philosophy that is evidenced based on many years of academic research with the following as keystone principles, when it comes to the equity component:

• Risk and Return are related – the greater the Risk, the greater the expected Return
• Small Cap stocks have a greater expected Return than Large Cap stocks given they have inherently greater associated Risk – (Size Premium)
• Value (or cheap) stocks have a greater expected Return than Growth stocks- (Value Premium)

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The ‘Size Premium’ is reasonably easy to understand.  All large companies were once small companies.  As an investor, if you buy a stock in a small company and due to it’s success it becomes a large company, you will do very well.  The risk of course is that not all small companies become large and some will fail.  This is the associated risk of investing in small cap stocks.  APC diversifies this risk by buying many ‘small cap’ stocks in our portfolios.   

The ‘Value Premium’ is also reasonably easy to understand.  An accountant values a company which is known as the ‘Book Value’.  The sharemarket will value the same company (it’s share price) and by multiplying the number of shares on issue by the share price this generates a ‘Market Value’.  Those companies that have a ‘Market Value’ less than the ‘Book Value’ are considered undervalued or ‘cheap’ and this is known as the ‘Value Premium’.  The reasons for this undervaluation can be varied however over time many of these of companies generate a greater return for investors given the greater associated risk of investing in ‘under-valued’ companies.  APC diversifies this risk by buying many ‘value’ stocks in our portfolios.

What is the Evidence?
As APC’s Investment Principles are based on a ‘rules based’ approach, it is possible to track how often the ‘Size Premium’ and the ‘Value Premium’ are evident over various time periods historically:

Based on this research APC’s portfolio ‘tilts’ towards ‘Small Cap’ stocks and ‘Value’ stocks will likely generate a greater Return than the broader market for the majority of the time, which historically has been the case.

So What Happened During the Last 12 Months?
However sometimes this is not the case and over the past 12 months both ‘Small Cap’ stocks and ‘Value’ stocks have underperformed ‘Large Cap’ and ‘Growth’ stocks both here in Australia and  overseas:

As illustrated above, both of the ‘tilts’ that APC adopt in the Australian and international shares sectors underperformed the broader market over the past year leading to the growth oriented APC Classic Portfolios underperforming their benchmarks for the first time in many years.

In Summary
Whilst these specific ‘tilts’ in APC’s Investment Philosophy are likely to generate greater portfolio returns over medium to longer timeframes, it is not always the case over shorter timeframes and in the 12 months to June this year we have experienced an absence of both the premiums we expect to observe. 

We understand this happens from time to time and have observed it before.

Past investment behaviour informs us that ‘Small cap’ and ‘Value’ stocks will likely return to generating an investment return premium but we just don’t know when. However when they do history illustrates their outperformance is likely to be significant and reward the patient investor.

As always, if you would like to discuss your portfolio with APC we would encourage you to contact any member of the advice team who will be happy to assist.