One of the key tenets of efficient investing is to tilt toward asset classes with an expected return that's historically proven to be higher than others.
The outperformance of small-cap and value is pretty standard three-factor-model material from the research of Eugene Fama and Kenneth French. These days, it's not uncommon to see portfolios structured using efficient market techniques, with a tilt toward small-cap and value investments.
But what if you don't really want to build your entire portfolio around that hypothesis but you still want a methodical way to get exposure to a high-performing asset class?
Clearly, there is more than one way to accomplish that goal, but let's look at one: Invest in a small-cap value fund. This approach to getting small-cap and value into your portfolio not only kills two birds with one stone by putting both asset classes into a fund but also reduces your risk of trying to pick the right bundle of single stocks.
Several mutual funds fall into the small-cap value category, but I want to begin with a look at Putnam Small Cap Value A Shares (PSLAX), which has even lower expenses than the funds marketed by Dimensional Fund Advisors (the service that my firm uses). The fund's overall expense ratio is 1.21%, lower than the Morningstar category average of 1.45%. (Yes, that's higher than Dimensional Fund Advisors.)
I'm not a big fan of gauging a fund's prospects by its past performance (because it's essentially irrelevant), but here are some numbers anyway: The fund's average return over the five years between 2009 and 2013 was 21.14%.
Year-to-date, the fund's 2014 return is a negative-1.24%. What to make of that? Probably not much. Small-caps often see a burst of upside trading near the end of the year, and frequently show the bulk of their gains in the fourth quarter, according to extensive research conducted by the Russell indices.
In addition -- and I really can't emphasize this enough -- past performance is no indicator of future returns. So that five-year average? It's an OK indicator of performance over rolling time periods, but it means nothing for the near-term returns. The current negative return for 2014? I'm not reading much into that at all. Remember: Think long term.
The top holding in the Putnam Small Cap Value A Shares is PNM Resources (PNM), which happens to be my electrical utility here in Albuquerque. Thanks in no small part to PNM, you are reading this column now.
Other top holdings include Empire District Electric (EDE), United Financial Bancorp (UBNK), Allied World Assurance (AWH), PartnerRe (PRE) and Summit Hotel Properties (INN). Not exactly a collection of fast growers that financial channel anchors love to chatter about but, hey, they're value stocks! That's the point!
I frequently remind readers that it's imperative to expand their investing horizons beyond the S&P 500. It's true that the S&P is a consistent solid performer, but it's equally true that other asset classes can pick up the slack when large-cap domestic stocks are a lagging asset class.