Resolute’s Implementation of Profitability

At Resolute, our investment allocation and approach are a high priority in our daily work and decision making. Recently, our portfolio design has undergone some revisions as we routinely assess the fundamentals of our investment philosophies. While there are multiple layers to this, we have just completed a focused analysis of our core equity fund holdings. Our team is now incorporating some changes based on this analysis, and we are excited to share this with you. If this impacts your portfolio, you will likely notice trade confirmations, as a result.

A Little Background:
Our investment philosophy has long been rooted in the principals stating, over time, stocks will outperform bonds, and within stocks: value will outperform growth, small-cap will outperform large-cap, and companies with higher profit margins will outperform companies with lower profit margins. Longer-term results show these factors have prevailed. In recent years, however, the most challenging component of these underlying philosophies has been the value approach. Over the past decade, growth stocks have outperformed value stocks by a wide margin.

As of June 30, 2019:

PERFORMANCE DATA REPRESENTED ARE BASED ON THE FAMA/FRENCH US LARGE VALUE RESEARCH INDEX AND THE FAMA/FRENCH US LARGE GROWTH RESEARCH INDEX WHICH SHOWS PERFORMANCE FOR THE PORTFOLIOS REPORTED AND INCLUDES REINVESTMENT OF DIVIDENDS AND OTHER EARNINGS. PERFORMANCE FOR PERIODS GREATER THAN ONE YEAR ARE ANNUALIZED. INDICES ARE NOT AVAILABLE FOR DIRECT INVESTMENT. TO OBTAIN THE MOST CURRENT MONTH-END PERFORMANCE DATA, VISIT US.DIMENSIONAL.COM.

  • The Fama/French US Large Growth Research Index has averaged 16.40% per year for the last 10 years, while its long-term average since inception of July 1, 1926, is 9.82 — large growth has performed at 167% of its long-term average over the past 10 years and has outperformed large value 7 of the past 10 years.
  • The Fama/French US Large Value Research Index has averaged 12.66% per year for the past 10 years, while its long-term average return since inception of July 1, 1926, is 11.90% — large value returns are near their historical average returns performing at 106% of its long-term average over the past 10 years.
  • The debate over “value-versus-growth” has endured for many decades. When you look at long-term returns you will see value has outperformed growth by almost 2.1% per year, thus, reinforcing our bias toward value. Recent returns certainly do beg the following questions: Is there a paradigm shift occurring due to the change in the makeup of our economy which may lead to the favoring of growth over value going forward? Or, is it simply that the pendulum has swung in favor of growth more recently, and now it is just a matter of time before it swings back toward value? These questions have been the focus of our recent analysis.

    Into the weeds:
    Value stocks, by definition, have a high book value relative to the price at which they trade (high book-to-market ratio). Growth stocks, in turn, have a low book value relative to the price at which they trade (low book-to-market ratio). In today’s economy, many technology stocks fall into the category of growth stocks for a variety of reasons. Primarily, many technology companies do not rely so heavily on a brick and mortar presence with millions of dollars in equipment that could be readily sold in a liquidation event. Another reason is that many expect faster growth in earnings and profits leading to increased investor interest and a willingness to pay higher prices based solely on that expected growth.

    Paradigm shift?
    With a strong emphasis on value, technology is one area that has been underweight in our portfolio allocation. Technology’s impact on our everyday lives is massive. It seems reasonable to our investment team that technology companies could be creating a paradigm shift that will continue to alter stock market returns from what we have come to expect based on past years’ data. We want to have a disciplined approach to not only have more exposure to this sector, specifically, but to those companies that do possess strong fundamentals without exhibiting high book values.
    Since we concluded technology is creating, at least, a minimal paradigm shift, the dilemma becomes increasing allocation to stocks that are part of this overall category knowing it has just performed at 167% of its long-term average. Aren’t many of these stocks overpriced and showing low profits? While we have established wanting to act, we also know we want to have a disciplined approach to implementation that goes beyond simply using an index fund.

    Pendulum swing?
    Historically, the pendulum has a way of swinging and there is a fear that when you decide you want to make a change due to underperformance, the pendulum swings back leaving you missing out on the dramatic rebound of the strategy you just exited. For example, in the 1990s growth was beating value effortlessly for many years, causing many to question the merits of investing in value stocks. In March of 2000, the stock market suffered a deep sell-off with large growth stocks taking the biggest hit. Twelve months after the sell-off began, those who had held on to value stocks were further ahead and more than made up for all the years of underperformance by March of 2001. Click here to read Dimensional’s article, published March 2019, “Perspective on Premiums.”
    Given the long-term persistence of the value premium and the historical reward for those who have maintained patience in the past, we concluded we do not want to make a large shift away from value stocks.

    A closer look at how the fundamental beliefs working together have performed.
    During our analysis, we compared 1-, 3-, 5-, and 10-year returns of our largest and most widely used equity fund holding, DFA U.S. Core Equity 2 (DFQTX) to the Russell 3000 Index. The Russell 3000 is a widely used barometer for measuring broad U.S. stock market returns as it tracks the 3000 largest publicly-traded companies in the U.S. This fund applies the fundamentals by tilting investments toward value, small, and high profitability stocks.
    To no surprise, for the period ending June 30, 2019, the fund underperformed during the 1-, 3-, and 5-year periods. However, the fund’s return was very close to the performance of the Russell 3000 over the total 10-year period.

    PERFORMANCE FOR THE PORTFOLIOS REPORTED NET OF FUND FEES BUT NOT ADVISORY FEES AND INCLUDES REINVESTMENT OF DIVIDENDS AND OTHER EARNINGS. INDICES ARE NOT AVAILABLE FOR DIRECT INVESTMENT. TO OBTAIN THE MOST CURRENT MONTH-END PERFORMANCE DATA, VISIT US.DIMENSIONAL.COM.

    It appears that applying the three fundamental philosophies within stocks led to remarkably similar results of the broad U.S. Stock market over 10 years, even though the value fundamental underperformed by such a wide margin. Recent underperformance of some of the premiums has led to lower recent returns, but not to underperformance over the longer term.

    Conclusion: We are not going to abandon our philosophies.

    Tying it all together.
    The decision to adhere to our fundamentals did not mean we were done. It simply helped us determine whether we were going to make changes on a grand scale, minor adjustments to our approach, or keep our target allocations exactly the same.
    Ultimately, we decided to make adjustments to our allocations to maintain the same fundamentals, overall, but with a slight shift to incorporate a greater degree of a single fundamental. This shift results in an increased emphasis on higher profitability stocks. As a result, we are adding Dimensional’s US Relative High Profitability Portfolio (DURPX)and International High Relative Profitability Portfolio (DIHRX) as holdings to replace 25% of the DFA US Core Equity 2 and International Core Equity portfolios, respectively. This approach allows us to have a heavier weighting on stocks that have higher profit margins yet may not have a book value appropriate to be considered a value stock.

    Our Solution:
    After all things have been considered, we believe the fundamentals drive long-term prices and buying stocks at the right valuation is important in any type of economy. Beyond any doubt, we do not feel a need to abandon our investment philosophy, but we do believe there is good reason to make an adjustment to apply the fundamentals we are rooted in by implementing a shift in emphasis.
    The resulting conclusion is an increased emphasis on allocating to high profitability stocks as a portion of our core equity holdings. This approach increases our allocations to large growth and large-blend stocks, but does so in a manner that selects companies with higher profit margins versus an index fund that would simply buy the entire category. It allows us to stand strong in our fundamental beliefs, while shifting more assets to an area where profits may be prevalent even when traditional book value is not.

    In Closing:
    We take portfolio decisions very seriously, as we understand the responsibility imparted to us by our clients to manage these assets. The Resolute Investment Committee takes care to apply patience in decision making and focus on removing emotion from allocation and trading decisions. While 1, 3, and 5-year periods may seem like a long time to some when we are living through them, in the grand scheme of things these are very short periods in time. Our goals are to help clients achieve long-term success and continue serving them long into future years. For these reasons, we continue to apply our fundamental beliefs that risk and return are related, markets are efficient over time, profitability matters, and diversification is key. These fundamental beliefs continue to be the core of both our short-term and long-term investment approach.

    As always, we look forward to our next conversation.

    The views expressed represent the opinion of Resolute Wealth Advisor, Inc. (RWA). The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While RWA believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and the RWA’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.