Phrases such as "elephants do ride" and "run your winners and cut your losses" evolving investment adages because they are often real enough to be accepted. There is, however, a world of difference between a good rule of thumb, and something that can inform reliable investment strategy. The bottom line for an investor is: does it work?
The excellent guide annual investment returns of Credit Switzerland and London Business School (lbs.) three of these beliefs is under the spotlight. Proffesors Dimson, Marsh and Staunton the lb overloaded numbers on the effect of size (small shares outperform big ones?), premium value (many labor markets shares are better than growth fast ones?) and momentum (must you return last year winners or losers?). Their conclusions probably disappoint Holy Grail claimants; It looks not as there is a free meal.
The frustrating thing for those seeking a shortcut to the success of investment is that, on the numbers of suggest there may be persistent prejudices that can be exploited by investors. As shown in the figure, £ 1 invested in the stock market UK in 1955 would be pushed to £ 822 at the end of 2010, 12 8pc annualized yield. Not bad, you might think, until you realise investment same index to the companies smaller Hoare Govett (actions that make up the smallest 10pc by the value of the UK market) have pushed £ 3,248 during the same period and the so-called micro-caps which make up the smallest 1pc reportedly worth £ 14,210 by the end of last year.
For much of the 1990s, l'effet smaller company just stopped working, and then, when everyone had abandoned it at the turn of the century, he struck again. The lost decade was essentially a matter of gros-cap.
Evidence for so-called value stocks outperforming the growth stocks is even more convincing at first glance. A study of the top 100 UK market shares goes all the way back to 1900 shows that £ 1 invested in 50 lower dividend yields (a proxy for the growth stocks) have pushed to £ 5,122 at the end of 2010. Still, you may think it was good enough, but only until you realise that an investment in the market as a whole would have pushed to £ 23,335 over the same period and an investment in 50 stocks with highest return (stock value) to a powerful £ 100,160.
Yet again, there is good reason to expect the value of stocks to outperform. It is compensation for the fact that almost by definition, they are lower than the shares of growth opportunities. But what is also clear is that if the expected yields adequately compensate higher-risk. My intuition is that it does, which explains why the best investors seem to share a denier, search for the character value.
Value stock outperformance is a reflection of our gullibility when it comes to attractive growth stories and our willingness to pay for them.
The third approach tested by the lb is even more difficult to use profitably. Yet again, the evidence suggests greenhouse pronounced momentum which choirs from actions which have recently surpassed causes future outperformance too. At the risk of blinding you with even more numbers, back-tests show to buy last year's losers would have net you 3 FP7 per year, while the winners of choirs have given you 14 3pc a year between 1900 and 2010. The power of compounding makes an absolutely phenomenal difference of total return. However, there are two caveats significant to remember with momentum investing. Firstly, in the real world, it is a very expensive strategy to be implemented because the transaction costs eat your statements very significantly. Secondly, as other effects there a bad habit to enter the opposite.
Momentum investor will not forget the whiplash hit they experienced in March 2009, when the market suddenly took off in the opposite direction and above the previous year has become the fastest risers of the market. Unfortunately, it y just not shortcuts.
Tom Stevenson is an investment at Fidelity International. The opinions expressed here and in his tweets (@ tomstevenson63) are its own
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