5000.1 The Science of Investing Duncan Orr Swindells Financial Planning
Jul 11, 2015
5000.1
The Science of
Investing
Duncan Orr
Swindells Financial Planning
Can I, or somebody I know,
reliably predict enough superior
performing investments, in
advance, that will create excess
return above the market, after
costs, for my clients?
Investing – 2 Major beliefs
You believe in the ability to select
superior investments e.g. shares,
property, bonds etc., or you don’t
You believe in the ability to time
markets, or you don’t
Key Principles
Diversify portfolios across countries, across
currencies, across asset classes e.g. Shares,
Property, Bonds & Cash and across asset class
styles e.g. Large/Small, Value/Growth etc…
Focus on the dimensions of risk that deliver higher
expected returns over the longer term
Maintain discipline and a commitment to a long term
investment strategy, avoiding attempts to market
time
Minimise costs e.g. Annual charges, Turnover and
Transaction charges
Why invest predominantly in the UK?
Home market bias ignores the
diversification benefits and investment
opportunities of overseas markets
Where Dimensional Invests: Developed Markets Emerging Markets Not Invested
In British pounds. Map reflects countries in the MSCI All Country World IMI Index, and MSCI Frontier Markets Index. Market cap data is free-float adjusted. MSCI data copyright MSCI 2010, all rights reserved. Many small nations not displayed. Totals may not equal 100% due to rounding. Dimensional makes case-by-case determinations about the
suitability of investing in each emerging market, making considerations that include local market accessibility, government stability and property rights before making investments. For educational purposes; should not be used as investment advice. 1. An example large cap stock provided for comparison.
United States 7,509
United Kingdom 1,528
Japan 1,504
Canada 745
France 736
Australia 600
Germany 558
Switzerland 519
China 405
Brazil 359
SCALETOP 20 NATIONS BY MARKET CAPITALISATION (£ BILLIONS)
Spain 306
South Korea 292
Taiwan 287
Italy 243
Sweden 195
Netherlands 189
India 183
Hong Kong 166
South Africa 162
Russia 131
World Market Capitalisation£17.7 Trillion as at December 31, 2009
Equity Returns of Developed MarketsAnnual Return (%)
In British Pounds1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Austria
121.51
Spain
115.61
Japan
12.41
Belg.
59.93
Austria
130.17
UK
-8.22
H.K.
54.07
H.K.
63.51
H.K.
121.68
Norway
16.88
Switz.
45.41
Spain
26.64
Switz.
50.29
Belg.
65.90
Sing.
105.39
Switz.
14.43
Austral.
4.35
Austria
5.36
Austria
42.11
Austria
59.93
Can.
43.18
Spain
31.24
H.K.
38.89
Japan
-1.85
Norway
66.52
Germ.
65.12
Italy
103.02
Spain
7.62
Den.
58.99
Germ.
65.12
H.K.
-9.15
Austral.
37.72
Switz.
44.90
Sing.
71.85
Japan
14.87
US
38.38
Sweden
24.07
Italy
41.18
Italy
50.84
Sweden
85.15
Can.
13.91
Austria
-3.15
Austral.
-10.82
Spain
40.02
Belg.
33.83
Japan
40.07
Sing.
28.91
Germ.
32.99
Switz.
-3.62
Austral.
57.05
Italy
85.78
Japan
94.35
UK
6.17
Sweden
54.43
Norway
64.27
Austria
-11.51
US
34.03
US
31.50
Switz.
49.12
Sweden
11.93
Sweden
34.59
H.K.
20.32
Den.
40.17
Spain
48.24
Japan
66.38
Den.
11.87
Belg.
-8.56
Norway
-16.16
Germ.
39.14
Norway
29.04
Austria
39.09
Norway
27.52
Norway
29.27
US
-13.44
Sing.
54.85
Switz.
64.97
Belg.
73.86
Can.
-10.46
Norway
48.26
Den.
62.45
Norway
-16.24
Sing.
28.74
Sing.
31.37
Norway
45.31
Neth.
5.66
Spain
31.00
Norway
16.32
US
38.96
France
39.97
H.K.
64.29
Norway
7.16
Spain
-9.01
Italy
-16.23
Sweden
39.14
Sweden
27.07
Den.
38.93
Sweden
25.99
Can.
27.44
Spain
-17.64
Sweden
46.13
France
45.95
France
73.83
Den.
-10.99
France
43.53
Sing.
60.61
Den.
-17.54
France
21.42
France
27.06
Sweden
40.17
Italy
5.52
Neth.
28.87
Can.
16.24
Spain
30.69
US
28.70
Can.
58.35
Italy
6.71
Norway
-9.92
Japan
-18.91
Can.
38.61
Italy
25.53
Norway
38.66
Den.
21.94
Sing.
26.25
France
-21.35
H.K.
42.56
Belg.
41.60
Sweden
61.40
Austral.
-14.13
Austral.
42.01
France
53.67
US
-19.41
Neth.
21.40
Neth.
26.43
Germ.
38.81
Belg.
2.38
Belg.
27.01
Neth.
15.30
Germ.
29.80
Germ.
28.01
Norway
35.62
Neth.
3.69
US
-10.09
Switz.
-18.92
Den.
36.94
Den.
21.98
Switz.
29.82
Belg.
20.08
Belg.
36.66
Can.
-24.45
Belg.
40.19
Norway
35.19
H.K.
52.14
Belg.
-15.22
Japan
40.95
Neth.
53.27
Neth.
-19.44
Den.
20.10
Belg.
21.79
Neth.
38.40
Sing.
0.93
H.K.
23.68
UK
15.23
Neth.
28.95
Switz.
22.17
France
33.13
France
3.46
UK
-11.81
Sing.
-19.60
Austral.
34.84
Austral.
24.53
Austral.
29.47
Austria
19.98
Den.
23.54
Germ.
-24.95
Can.
39.03
Den.
28.52
Sing.
41.50
Neth.
-15.85
Sing.
38.84
Sweden
48.80
Switz.
-21.96
UK
19.55
UK
19.06
Austral.
38.30
Austral.
-0.30
UK
22.36
US
11.44
UK
27.75
Neth.
21.86
US
25.57
Austral.
-2.63
Den.
-12.57
Can.
-21.55
Norway
25.35
Spain
20.22
Sing.
27.63
Germ.
19.49
Spain
21.92
Sing.
-27.00
Spain
27.72
Neth.
27.98
Austral.
38.68
Norway
-16.95
H.K.
33.37
US
46.75
Germ.
-24.58
Switz.
19.27
Germ.
10.89
Den.
35.88
Germ.
-1.00
Den.
19.85
Den.
10.14
Belg.
18.32
UK
16.52
Germ.
23.63
UK
-4.35
H.K.
-16.47
Belg.
-23.13
Italy
24.27
H.K.
16.53
Neth.
27.05
France
18.17
Neth.
18.61
Den.
-27.29
UK
27.56
Sweden
25.83
Neth.
37.16
US
-19.11
Germ.
25.57
Switz.
42.45
Belg.
-25.92
Spain
19.14
Austria
10.45
Spain
32.76
Den.
-1.85
Can.
19.37
France
9.58
Sweden
17.66
Sweden
12.70
Austral.
21.14
Austria
-4.82
Can.
-18.36
UK
-23.37
France
23.93
Sing.
14.00
Sweden
23.09
Italy
16.42
France
11.38
Neth.
-28.20
Austria
27.47
Spain
24.06
Germ.
31.86
Sing.
-19.59
Can.
21.88
Can.
40.31
Sing.
-26.51
Sweden
17.91
Austral.
10.20
Italy
31.50
Switz.
-2.06
Germ.
17.46
Austral.
5.32
Can.
17.52
Den.
7.78
UK
15.81
US
-5.86
Switz.
-19.30
Spain
-23.43
Japan
22.21
Can.
13.95
Germ.
22.66
Neth.
15.45
UK
6.59
UK
-28.37
Neth.
26.63
UK
22.71
Austria
31.33
Austria
-19.64
US
19.33
UK
37.65
Can.
-27.58
Belg.
17.22
Can.
8.60
Austria
31.05
US
-4.33
France
15.15
Germ.
2.69
France
16.63
Austral.
4.90
Den.
15.44
H.K.
-7.82
Neth.
-20.07
Den.
-24.11
Belg.
18.99
UK
11.49
France
22.62
Austral.
14.99
Italy
4.32
Sweden
-30.48
Den.
21.57
H.K.
21.62
Switz.
29.99
Sweden
-19.82
Neth.
18.87
Italy
34.79
Spain
-28.30
Can.
14.46
Sweden
5.76
Japan
28.35
UK
-6.93
Austral.
12.19
Italy
1.80
Norway
10.71
Japan
3.87
Neth.
10.08
Germ.
-8.74
France
-20.32
H.K.
-25.69
UK
18.04
France
10.48
Belg.
21.69
UK
14.77
US
3.71
Italy
-30.64
France
17.35
Japan
14.68
UK
23.74
H.K.
-24.63
Spain
18.22
Belg.
32.40
France
-28.30
Japan
12.23
Japan
-2.91
UK
27.30
Can.
-8.27
Sing.
7.44
Belg.
1.30
Austria
5.84
Austria
-0.77
Spain
7.87
Spain
-9.02
Germ.
-20.35
Neth.
-28.44
H.K.
16.85
Germ.
8.32
H.K.
20.96
H.K.
14.54
Switz.
3.57
Austral.
-31.61
Italy
12.67
US
5.10
US
13.33
Switz.
-28.83
Italy
16.05
Spain
23.88
Austral.
-31.37
Germ.
11.45
Spain
-3.43
Belg.
26.37
Spain
-9.96
Norway
6.98
Austria
-5.50
Austral.
-6.68
H.K.
-3.98
Italy
2.72
Belg.
-10.09
Sing.
-21.41
France
-28.76
Switz.
16.05
Japan
8.03
UK
19.80
Switz.
11.95
Austria
0.50
H.K.
-32.35
US
12.39
Austral.
-4.14
Can.
7.14
France
-32.26
Switz.
10.54
Austral.
23.36
Italy
-32.76
Italy
1.15
Italy
-3.86
France
23.70
France
-10.31
Italy
1.96
Switz.
-7.53
H.K.
-20.07
Can.
-7.16
Switz.
-7.53
Sweden
-14.88
Italy
-24.67
US
-30.48
US
15.47
Switz.
7.19
US
17.33
Can.
3.52
Sweden
-1.03
Norway
-50.42
Switz.
11.55
Can.
-7.75
Den.
-1.32
Italy
-38.14
UK
10.29
H.K.
22.34
Sweden
-34.26
Austria
-9.56
Norway
-3.97
Can.
20.31
Austria
-11.35
Japan
1.61
Sing.
-15.80
Japan
-20.47
Sing.
-13.83
Austria
-6.39
Sing.
-21.85
Sweden
-25.26
Sweden
-37.17
Sing.
15.30
Neth.
4.65
Spain
16.51
US
0.77
Belg.
-4.32
Belg.
-53.53
Germ.
11.41
Sing.
-37.61
Norway
-5.00
Germ.
-40.85
Austria
4.27
Japan
14.82
Japan
-46.84
Norway
-12.93
Den.
-11.32
US
11.67
H.K.
-32.76
Austria
-3.87
Japan
-23.87
Sing.
-27.12
Norway
-30.83
Belg.
-11.70
Japan
-22.32
Japan
-27.56
Germ.
-39.61
Neth.
10.43
US
2.69
Italy
13.71
Japan
-6.64
Japan
-5.80
Austria
-56.20
Japan
-5.42
Highest
Return
Lowest
Return
Source: MSCI developed markets country indices (net dividends) with at least twenty-five years of data. MSCI data copyright MSCI 2009, all rights reserved.
This material has been distributed by Dimensional Fund Advisors Ltd., which is authorised and regulated by the Financial Services Authority. Past performance is no guarantee of future results.
Understanding Stock market
performance
The Value and Small cap
premiums
Increased
Expected
Return
Three Factors Determine
Returns
Equity Market
Stocks have higher expected returns
than fixed income.
Company Size (market cap)
Small cap stocks have higher expected
returns and risk than large stocks.
Company Price
Less healthy and lower-priced “value”
stocks have higher expected returns
and risk than more healthy and higher-
priced “growth” stocks.
Investment Philosophy
Small
Growth
(Low
BtM)
Value
(High BtM)
Large
Total
Stock Market
The Dimensions of Stock Returns
Value stocks are above the 30th percentile in book-to-market ratio. Growth stocks are below the 70th percentile in book-to-market ratio.
Simulations are free-float weighted both within each country and across all countries. UK and Europe data provided by London Business
School/StyleResearch.
US value and growth data provided by Fama/French. This material has been distributed by Dimensional Fund Advisors Ltd., which is authorised and regulated
by the Financial Services Authority. Past performance is no guarantee of future results.
Size and Value Effects Are Strong around the World
Annual Index Data
Percent per Annum in £
An
nu
alis
ed
Com
po
un
d R
etu
rns (
%)
Standard
Deviation (%)
15.81
12.08
10.43
19.15
15.62
12.59 12.15
9.538.15
13.02
10.73
8.20
10.34 9.798.95
13.59
11.49
8.72
17.97
13.30
10.81
UK
Large
Value
UK
Large
Market
UK
Large
Growth
UK
Small
Value
UK
Small
Market
UK
Small
Growth
Europe
Large
Value
Europe
Large
Market
Europe
Large
Growth
Europe
Small
Value
Europe
Small
Market
Europe
Small
Growth
US
Large
Value
S&P
500
Index
US
Large
Growth
US
Small
Value
CRSP
6-10
Index
US
Small
Growth
Emg.
Markets
Value
Emg.
Markets
“Market”
Emg.
Markets
Growth
UK Large
Capitalisation
Stocks (£)
1956-2009
UK Small
Capitalisation
Stocks (£)
1956-2009
Europe ex UK
Large
Capitalisation
Stocks (€)
1981-2009
Europe ex UK
Small Capitalisation
Stocks (€)
1981-2009
US Large
Capitalisation
Stocks ($)
1927-2009
US Small
Capitalisation Stocks
($)
1927-2009
Emerging Markets
Capitalisation
Stocks ($)
1989-2009
32.08 28.60 26.29 31.81 30.34 30.83 27.22 23.29 25.76 26.10 24.80 27.51 27.17 20.63 22.06 35.30 31.09 34.20 43.04 37.29 35.70
Source: UK Market is the FTSE All-Share Index. FTSE data published with the permission of FTSE. UK Value simulated by Dimensional from Bloomberg securities
data, prior to 1994 data provided by London Business School. This material has been distributed by Dimensional Fund Advisors Ltd which is authorised and
regulated by the Financial Services Authority. Past performance is no guarantee of future results.
Rolling Time Periods 1 Year 3 Years 5 Years 10 Years 15 Years 20 Years 30 Years 40 Years
Number of Periods 643 619 595 535 475 415 295 175
Periods UK Market > UK One-Month T-
Bills 452 498 514 528 472 415 295 175
UK Value vs. UK Market
Monthly: July 1955-December 2009
5340.3
70%
80%86%
99% 99% 100% 100% 100%
Percentage of All Rolling Periods Where UK Value Outperformed UK Market
66%70% 73%
77% 78% 77%
100% 100%
Source: UK Small simulated by Dimensional from StyleResearch securities data; prior to July 1981, Hoare Govett Smaller Companies Index, provided by the
London School of Business. UK Market is the FTSE All-Share Index. FTSE data published with the permission of FTSE. This material has been distributed by
Dimensional Fund Advisors Ltd., which is authorised and regulated by the Financial Services Authority. Past performance is no guarantee of future results.
Percentage of All Rolling Periods Where UK Small Outperformed UK Market
Rolling Time Periods 1 Year 3 Years 5 Years 10 Years 15 Years 20 Years 30 Years 40 Years
Number of Periods 647 623 599 539 479 419 299 179
Periods UK Small > UK Market 425 435 440 417 376 323 298 179
UK Small vs. UK Market
Monthly: March 1955-December 2009
Risk Factors Have Periods of Under- and Over-Performance
1957-2009
In GBP
Our source of share price and listing information was the London Share Price Database (LSPD) maintained at the London Business School. The master index of this
database covers all listed stocks in the UK market since 1957. We selected stocks officially listed on the LSE and excluded foreign companies and investment trusts.
To choose the value sectors we rank the universe by book-to-market and approximately the top 30% is the value universe. The small sectors we rank the universe by
market capitalisation and approximately the bottom 10% is the small universe.
Copyright © 2003 Elroy Dimson, Stefan Nagel and Garrett Quigley. UK research data provided by the London School of Business.
• From year to year, stocks with high book-to-market ratios and smaller market caps do not always produce higher returns.
• Over longer time periods, the size and value premiums are more prevalent.
• Investors that maintained disciplined size and value exposure were ultimately rewarded.
Pe
rce
nt p
er
Ye
ar
Size Premium
Value
Premium
Pe
rce
nt p
er
Ye
ar
2009
2009
Attempts to time markets are risky
Market timing involves knowing when
to buy, when to sell and when to buy
again
No evidence to demonstrate that this
can be successfully and consistently
achieved over the longer term
£9,850
£8,230
£6,257
£3,963
£2,699
£5,105
£7,412
FTSE data published with the permission of FTSE.
Long-Term Govt. Bonds are the Citigroup World Government Bond Index UK 1-30+ Years, copyright 2009 by Citigroup.
This material has been distributed by Dimensional Fund Advisors Ltd., which is authorised and regulated by the Financial Services Authority.
Past performance is no guarantee of future results.
Gro
wth
of £
1,0
00
Annualised
Compound
Return
One-Month
T-Bills
7.03%
Missed 25
Best Days
4.41%
Missed 15
Best Days
6.17%
Missed
5 Best
Days
8.30%
Missed 1
Best Day
9.60%
Total
Period
10.00%
Long-Term
Govt.
Bonds
8.70%
Performance of the FTSE All-Share Index
January 1986-December 2009
Fees Matter
£4,983,951
£3,745,318
£2,806,794
£ 1,000,000
£2,000,000
£3,000,000
£4,000,000
£5,000,000
1 Year 3 Years 5 Years 10 Years 20 Years 30 Years
Time
1% Fee
2% Fee
3% Fee
Bri
tish
Po
un
ds
Assumed 6.5% Annualised Return over 30 Years
Fees matter.
Over long time periods, high
management fees and related
expenses can be a significant
drag on wealth creation.
Passive investments generally
maintain lower fees than the
average actively managed
investment by minimising
trading costs and eliminating
the costs of researching
stocks.
For illustrative purposes only.
5430.1
The role of Fixed
Interest investments
within a portfolio
Fixed Interest Investing
One aspect of fixed interest’s role in a portfolio is to
reduce volatility.
This may be accomplished by employing:
Shorter maturities with lower equity
correlations.
High-quality issues.
A global approach that hedges all
currencies.
5520.1
Does It Pay to Extend Maturities?
1900-2000
• Not all investors define
risk as standard
deviation. Some
investors may seek to
hedge long-term bonds.
• Historically, longer
maturity instruments
have higher standard
deviations and have not
provided consistently
greater returns.
UK
BillsUS
Bonds
UK Bonds
US
Bills
US
EquitiesUK
Equities
15
10
5
0
5 10 15 20 25
Standard
Deviation (%)
5250.1
Bills Bonds Equities
UK US UK US UK US
Annualised Compound Returns
(%)
5.10 4.00 6.00 5.30 11.60 11.60
Annualised Standard Deviation
(%)
3.80 2.80 12.00 8.20 21.70 19.90
Dimson, Elroy, Paul Marsh, and Mike Staunton. Millennium Book II: 101 Years of Investment Returns. ABN AMRO and London Business School, 2001. This publication defines the data used
for the above chart and matrix as follows: UK Bills are UK One-Month Treasury Bills (FTSE). UK Bonds are the ABN AMRO Bond Index. UK Equities are the ABN AMRO/LBS Equity Index.
US Bills are commercial bills 1900-1918 and One-Month US Treasury Bills (Ibbotson) 1919-2000. US Bonds are government bonds 1900-1918, the Federal Reserve Bond Index 10-15 Years 1919-1925, Long-Term Government Bonds (Ibbotson)
1926-1998, and the JP Morgan US Government Bond Index 1999-2000. US Equities are Schwert’s Index Series 1900-1925, CRSP 1-10 Deciles Index 1926-1970, and the Dow Jones Wilshire 5000 Index 1971-2000.
Re
turn
(%)