Another example is that, for the same 40-year period, U.S. small-cap growth stocks returned just 5.1 percent, underperforming long-term Treasury bonds by 3.9 percentage points a year. Let's look at one more example where investors confuse strategy with outcome.
Consider an investor who begins in 2007. Having reviewed the data on various asset classes, he observes that from 1927 through 2006, value stocks have provided an annual average premium over growth stocks of 5.3 percentage points. So he decides upon a significant allocation to value stocks. Over the next five calendar years, the value premium is negative in four of them. It was negative through July 2012 as well. The total return underperformance was almost 17 percent.
Confusing strategy with outcome, the investor abandons his plan and sells his value stocks. The problem occurs because the investor did not understand that, while there has indeed been a large value premium, the premium has been highly volatile. The annual standard deviation has been 12.3 percent. That means there can be long periods when the premium can be negative.
To help you better understand of the persistence of risk premiums, my colleague and co-author, Jared Kizer, took a look at the issue. He explored the consistency of the market, size, value and momentum premiums using U.S. stock market data from the Fama-French data series for the period from 1927 through June 2014.
Consistency is important because it gives you a sense of how frequently the unexpected happens; for example, bonds outperforming stocks or growth outperforming value.
The table below shows the consistency of each return premium over monthly, annual and independent five-year periods.
|Positive Months (%)||60||51||55||64|
|Positive Years (%)||69||56||63||84|
|Positive 5-Year Periods (%)||88||65||76||94|