1. It’s no wonder Pepsi was presented as the winner. In similar fashion, no one is surprised when brilliant backtests roll off quant desks year after year. We’re reminded of an old joke among consultants: There’s no such thing as a bad backtest!
2. We believe a strategy must pass certain tests to be considered a robust source of return premium. For example, a strategy should deliver long-term excess return 1) across various geographies, 2) after reasonable variations in the definition or construction of the factor underlying the strategy, and 3) after surviving extensive out-of-sample data and stringent data-snooping thresholds. The return premium should also be founded on a credible rationale, whether related to a macro risk exposure or a behavioral bias. More criteria and details are available in Hsu and Kalesnik (2014).
3. Most investors—even today—would be shocked to learn the excess return of stocks was negative for the 40-year span ending February 2009. From early 1969 through early 2009, US Treasury bonds beat the S&P 500. More details are available in Arnott (2011, p. 74).
4. The rebalancing orientation of the Fundamental Index strategy increases the exposure to value when value is attractively priced and lessens exposure to value when value is fully priced.
5. One of our three core investment beliefs, the statement leads to our central investment philosophy that the largest and most persistent active investment opportunity is long-horizon mean reversion. Count us in the behavioral camp! Read more about our three investment beliefs in Brightman, Treussard, and Masturzo (2014).
6. RVKuhns conducted a survey that analyzes the portfolio allocations of 116 US public retirement plans as of June 30, 2015.
7. A win rate is calculated as the number of observations in which stocks beat bonds or RAFI™ beats the S&P 500, divided by the total number of observations. For example, on a 15-year rolling basis over the period 1962–2015, stocks beat bonds 384 times out of a total of 469 outcomes, resulting in a win rate of 82% (384/469).
8. Excess return is a zero-sum game: in aggregate, all investors earn the market return. To understand more about why investors take the other side of “value trades” and therefore may be funding the value premium, please see Hsu and Viswanathan (2015) and West and Larson (2014).
9. Our analysis assumes professionals begin working at the age of 25. All calculations are as of December 31, 2015. For instance, the 25- to 30-year-old worker cohort has an experience set from January 2010 through December 2015, and a 30- to 35-year-old worker cohort has an experience set from January 2005 through December 2015. We continue this exercise using five-year increments until we reach the 65- to 70-year-old worker cohort, which has an experience set from January 1970 through December 2015. The average collective experience is computed as the simple equal-weighted average of annualized excess returns (of stocks versus bonds, or of RAFI versus the S&P 500) across all cohort experience sets.
10. Over rolling 15-year periods from January 1962 through December 2015, the annualized real return of stocks averaged 6.2%. Excluding the impact of rising valuations, the real return is 4.6% a year. Thus, more than 150 basis points of performance a year was earned solely because stocks became more expensive. Over the same period, 20-year US Treasuries reduced their annualized average 15-year rolling real return from 3.2% to 2.8%, after adjusting for the return effect of interest rate changes. The return increase from an overall decline in 20-year US bond yields, from a high of 14.1% in September 1981 to 3.0% in December 2015, may have been largely offset by lower income on reinvested cash flows.
11. Value is currently cheaper than at any time other than the height of the Nifty Fifty, the tech bubble, and the global financial crisis. For more information, we invite you to read Arnott et al. (2016).
12. Our long-term return estimate for a 60/40 portfolio is found on our Asset Allocation site.
13. Pensions have many stakeholders, not one “owner.” Stakeholders include the eventual pension beneficiaries, the pension sponsor that officially owns the assets, the future shareholders and taxpayers who are impacted if returns fail to match the pension return expectations, and so forth.
14. More details from the survey can be found at “Corporate Pension Plan Funding Levels Showed Little Change in 2015.”
15. The eVestment Alliance’s All Lifecycle/Target Date universe includes more than 380 funds across 10 designated retirement-year vintages. The analysis is as of March 31, 2016.
16. As noted earlier, although the concept of value investing has long been understood, investors could not actually invest in the Fundamental Index, until after its introduction in 2005.
17. Over the five years following February 28, 2009, US stocks returned 154.7% and 20-year US Treasuries returned 6.3%, representing a cumulative excess return of 148.4%. Over the five years following February 29, 2002, RAFI returned 44.3% and the S&P 500 returned −15.8%, representing a cumulative excess return of 60.1%.
Arnott, Robert. 2011. “Equity Risk Premium Myths.” in Rethinking the Equity Risk Premium. Edited by P. Brett Hammond, Jr., Martin L. Leibowitz, and Laurence B. Siegel. Charlottesville, VA: Research Foundation of CFA Institute.
Arnott, Robert, Noah Beck, Vitali Kalesnik, and John West. 2016. “How Can ‘Smart Beta’ Go Horribly Wrong?” Research Affiliates, February.
Arnott, Robert, Jason Hsu, and Philip Moore. 2005. “Fundamental Indexation.” Financial Analysts Journal, vol. 61, no. 2 (March/ April):83–99.
Brightman, Chris, Jonathan Treussard, and Jim Masturzo. 2014. “Our Investment Beliefs.” Research Affiliates, October.
Graham, Benjamin, and David Dodd. 1934. Security Analysis. New York, NY: McGraw-Hill.
Hsu, Jason, and Vitali Kalesnik. 2014. “Finding Smart Beta in the Factor Zoo.” Research Affiliates, July.
Hsu, Jason, and Vivek Viswanathan. 2015. “Woe Betide the Value Investor.” Research Affiliates, February.
McClure, Samuel, Jian Li, Damon Tomlin, Kim Cypert, Latane Montague, and P. Read Montague. 2014. “Neural Correlates of Behavioral Preference for Culturally Familiar Drinks.” Neuron, vol. 44, no. 2, (October):379–387.
McFarland, Brendan. 2016. “Corporate Pension Plan Funding Levels Showed Little Change in 2015.” Willis Towers Watson, February 10.
West, John, and Ryan Larson. 2014. “Slugging It Out in the Equity Arena.” Research Affiliates, April.
Woolfolk, Mary, William Castellan, and Charles Brooks. 1983. “Pepsi versus Coke: Labels, Not Tastes, Prevail.” Psychological Reports, vol. 52 (February):185–186.