Diversification Scorecard: Q4 2020
January 21, 2021
Markets surged higher to close out November and December of 2020, as several uncertainties facing the markets were resolved, helping to push indices higher. The fourth quarter was centered on the US election and the positive news of effective vaccines for COVID-19. Still, new infection rates rose significantly in the US and Europe over the fourth quarter, signaling that although we can see a light at the end of the tunnel, we are not yet out of the woods. Federal Reserve Chair Jerome Powell indicated that rates would continue to stay at current near-zero levels, and that it would continue to purchase at least $80 billion in Treasurys and at least $40 billion in agency MBS per month until it feels “substantial further progress” has been made toward its goals. The election that many feared as a highly volatile trigger was digested well by market participants, allowing investors to move forward. Amid these developments, investors mostly shrugged off any concerns, absorbed lukewarm economic data, and bid up equities to record highs. We discuss how diversification held up in the fourth quarter and in all of 2020.
In Q42020, diversification was highly beneficial. Within equity allocations, small cap stocks outpaced large cap, with the Russell 2000 Index up 31.37%, compared with 12.15% for the S&P 500 Index. Mid cap also outperformed large cap, with the Russell Mid Cap Index returning 19.91%. International and emerging markets outperformed domestic equities, with the MSCI EAFE Index up 16.05% and the MSCI EM Index up 19.70%, as a weak dollar, suffering its worst Q4 since 2003, pushed investors toward foreign equities. Value outpaced growth stocks, breaking from a longer-term trend, as the Russell 1000 Value Index gained 16.25%, compared with a gain of 11.39% for the Russell 1000 Growth Index. Within fixed income, high yield and global bonds outperformed domestic core fixed income, with the Bloomberg Barclays Corporate High Yield Index gaining 6.45%, and the Bloomberg Barclays Global Aggregate ex U.S. Index gaining 5.09%. These returns were in stark contrast to a more muted return of 0.67% for the Bloomberg Barclays U.S. Aggregate Bond Index.
Full-year results showed that portfolio diversification proved its worth in 2020. Small cap outperformed large cap stocks, emerging markets outperformed developed markets equities, and global bonds outpaced domestic fixed income. Large cap US stocks remained the main focus for investors seeking both appreciation and current returns, with the S&P 500 Index gaining a solid 18.40%. Growth stocks largely outpaced their value peers, with the Russell 1000 Growth Index rising 38.49%, compared with 2.80% for the Russell 1000 Value Index, a massive gap of 3569 basis points. Investors owning some growth stocks, or a mix of growth and value, rather than just the S&P 500 Index, enjoyed positive portfolio performance. High-octane growth stocks were especially in favor, with many single stocks skyrocketing, such as Tesla, which gained 743.44%; Peloton, which gained 434.23%; and Zoom Video, which gained 394.94%. The IPO market surged, with some stocks gaining more than 100% in their opening day of trading. International developed was a laggard relative to domestic stocks, with the MSCI EAFE Index gaining 7.82%. From a fixed income standpoint, the Bloomberg Barclays Global Aggregate Bond Index ex U.S. Index gained 9.20%, compared with 7.51% for the Bloomberg Barclays U.S. Aggregate Bond Index. However, bank loans, corporate high yield, and commodities all lagged from a diversification standpoint, trailing both broad market equities and fixed income.
As we look forward and ponder the potential for diversification in 2021, it may be worthwhile to check in on the last five years’ trailing returns of diversification, as those results may suggest trends that are set to continue. However, they also may serve to highlight opportunities in asset classes that have trailed and have been overlooked. Over the past five years, the S&P 500 Index has delivered an incredible 15.2% annualized return. That return has been heavily skewed toward growth over value, evidenced by the 21% annualized return of the Russell 1000 Growth Index, compared with 13.26% for the Russell 1000 Value Index, a difference of 774 basis points annually. Although the gap may narrow in the coming years if value comes back in favor, exposure in both areas has benefited investors. International developed has lagged domestic equities, with the MSCI EAFE Index returning an annualized 7.45% return. Commodities, with an annualized return of 1.03%, may be a coiled spring ready to explode higher. Within fixed income, credit has ruled with corporate high yield, bank loans, global bonds, and emerging markets debt outpacing domestic fixed income. Investment grade may be in favor over credit, or it is possible that international and emerging markets bonds will be the top performers in fixed income asset classes moving forward.
In reviewing 2020 results and thinking about the year ahead, it is important for investors to remain aware of the benefits of diversification, staying focused on their long-term financial plan rather than letting short-term returns dissuade them from their goals.
- Growth outperformed value across all market capitalizations.
- Small cap outperformed large cap; mid cap trailed large cap.
- Domestic equity outpaced international developed. Emerging markets outpaced domestic stocks.
- Investment grade bonds outpaced high yield, and global fixed income outpaced domestic.
- Information Technology and Consumer Discretionary were the strongest S&P 500 Index sectors.
- International developed stocks mostly trailed domestic equities.
- Value lagged growth across all market capitalizations.
- REITs and commodities trailed global equity returns.
- Energy, Financials, and Real Estate were the poorest-performing S&P 500 Index sectors.
- Bank loans, emerging markets bonds, and short-term bonds underperformed core fixed income.
|Asset Class Returns*
||5 YR (ann)
|Large Cap Growth
|Large Cap Core
|Large Cap Value
|Mid Cap Growth
|Mid Cap Core
|Mid Cap Value
|Small Cap Growth
|Small Cap Core
|Small Cap Value
|Emerging Market Bonds
* Data from Morningstar. Asset classes represented by (in order of table): Russell 1000 Growth TR USD, Russell 1000 Value TR USD, Russell Mid Cap Growth TR USD, Russell Mid Cap Value TR USD, Russell 2000 Growth TR USD, Russell 2000 Value TR USD, MSCI EAFE NR USD, MSCI EM NR USD, Bloomberg Commodity TR USD, DJ US Select REIT TR USD, BBgBarc US Govt/Credit Interm TR USD, BBgBarc US Govt/Credit 1-3 Yr TR USD, BBgBarc US Corporate High Yield TR USD, BBgBarc US Treasury US TIPS TR USD, BBgBarc Global Aggregate TR USD, JPM EMB