Chart of the week
Structural Outperformance
If an investor beat the S&P 500 56% of the time over 60 years while earning an annualized return 1.3% greater than the S&P per year, you’d probably think that investor opened a hedge fund, charged heinous fees, and eventually retired to start a family office. In reality, that record belongs to any person that invested in the equally weighted version of the S&P 500 instead of the market capitalization weighted S&P 500.
The outperformance of the equal weighted S&P 500 can mostly be attributed to a greater exposure to the size and value factors that have a proven long term premium. To maintain the equal weighting of the index over time, the portfolio must rebalance in a contrarian way - selling recent winners and buying recent losers - while the market cap weighted S&P 500 becomes more concentrated in the largest companies. The evidence is clear, but the real point is that outperformance in investing requires thinking differently.
The performance gained from a simple shift in how an investment is structured (market cap to equal weight) begs the question - Where else in a portfolio can a performance edge be had by rethinking the structure? What about at the portfolio level?
A simple example of thinking differently about portfolio structure:
Investor X commits 100% of his capital to a vanilla 60-40 stock-bond portfolio. Fine.
Investor Y commits 67% of her capital to a 1.5x levered 60-40 stock-bond portfolio which replicates a full exposure to a 60-40 portfolio and leaves 33% of her capital as cold hard cash in her pocket. This capital can be used as dry powder for capital calls, real estate investing, a donation to charity, personal consumption, or……for an allocation to truly diversifying strategic alternatives like trend following, gold, commodities, etc. Now that’s awesome.
Retail investors have access to the products that enable this very example above. Check it out here.
Sources - Larry Swedroe, Why do equally weighted portfolios beat value-weighted ones?, An update to the Levered 60-40