Diversification Scorecard: Q4 2019
January 9, 2020
As markets wrapped up the second decade of the 2000s, equities surged higher to finish 2019. Market participants continued to look past any underlying threats to the sustained growth that has pushed stock indices to record highs, disregarding trade conflict between the US and China, slowing global growth, and various geopolitical concerns. Positive developments were given a higher priority among investors, who rallied behind the longest US economic expansion in postwar history, and an aging bull market not yet ready to quit. Central bank accommodation returned in 2019 as a key driver for stock appreciation, with the Federal Reserve cutting rates three times for a total reduction of 75 basis points.
For the full year, large cap domestic stocks led, with the S&P 500 gaining 31.5%, outpacing international equities, which returned 22.7% for the MSCI EAFE, and small cap equities, which experienced a 25.5% gain on the Russell 2000 Index. Growth stocks continued their dominance over value stocks, with higher returns for growth-oriented stocks across all market caps. Emerging markets equities trailed developed stocks, with the MSCI Emerging Markets Index gaining 18.9% for the year. However, its strong gain of 11.9% in Q4 led all major indices for the quarter. Within fixed income, the Barclays US Aggregate Bond Index posted a solid return of 8.7% behind lower interest rates. High yield bonds added value, while global bonds and shorter-duration debt trailed.
Diversification offered little benefit in 2019, as a portfolio invested 60% in the S&P 500 Index and 40% in the Barclays US Aggregate Bond Index would have returned 22.4%, outpacing a fully diversified portfolio allocation. This type of diversification failure is one that has proven common over the past decade, as US stock markets operated under conditions that included ultra-low interest rates, widespread central bank accommodation, strong consumer spending, and a more robust domestic economy than Europe or Asia. Although the US-centric stock rally of the past decade has done little to showcase the principles of diversification, analyzing the 2000-2009 period may provide a closer perspective of what the next ten years may have in store.
Over the ten-year period of 2000-2009, diversification across multiple asset classes and investment styles was highly in favor. Domestic equities mostly trailed international by 250 basis points annually, with a return of -1.0% for the S&P 500 Index versus an annualized return of 1.6% for MSCI EAFE. Emerging markets equities had a strong decade, posting a 10.1% annualized return. Small cap stocks outpaced large cap, with a 3.5% annualized return for the Russell 2000 Index. Value stocks widely outpaced growth stocks, with an annualized difference of 646 basis points within the Russell 1000 Index. REITs gained an annualized return of 10.7%, and commodities (one of the worst performers from 2010-2019) performed well in the 2000s, with an annualized return of 7.1%. Within fixed income, high yield, Treasury Inflation-Protected Securities (TIPS), emerging markets debt, and global bonds added value, even with a strong decade for the Barclays Aggregate Bond Index, which returned 6.3% annually.
The 2000s decade is widely remembered for the major events that drove performance, including the tech bubble and its bursting, September 11, the rise of the housing bubble, the global financial crisis, and the start of the subsequent market recovery. Among these events, diversified investors benefited, as exposure to international, small and mid-cap stocks, value stocks, emerging markets, commodities, and diversified fixed income added value, while the S&P 500 Index and growth stocks in general provided negative returns.
The juxtaposition of the 2000s and the 2010s help to showcase the widespread performance difference that investors experienced while practicing diversification. Will we return to the asset allocator’s utopia of the 2000s, or will the performance profile of the 2010s linger, with US large cap dominance, growth at any price, and diversification continuously taking a back seat? Only time will tell, but taking a balanced approach to diversification continues to be our favored and most prudent position, as it provides the benefit of lowering overall portfolio risk, and as we have seen from the 2000s results, does not have to come bearing the expense of worse returns.
- Growth outperformed value, with 985 basis points difference within the Russell 1000 Index. Technology was the top-performing sector, while energy was the worst-performing sector.
- High yield bonds outpaced core fixed income.
- Domestic equities outperformed international stocks.
- Emerging markets equities trailed developed markets stocks.
- Global bonds trailed domestic fixed income; however, emerging markets debt outperformed.
- Small cap stocks trailed large cap, with the S&P 500 Index returning 31.5% compared with 25.5% for the Russell 2000 Index. Mid cap stocks performed better but finished slightly behind large cap.
- Commodities widely trailed global equities and finished slightly behind core fixed income.
|Asset Class Returns*
|Large Cap Blend
|Large Cap Growth
|Large Cap Value
|Mid Cap Growth
|Mid Cap Value
|Small Cap Growth
|Small Cap Core
|Small Cap Value
|Int'l Developed Markets
|Core Fixed Income
|High Yield Bonds
|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, Russell 2000 TR USD MSCI EAFE NR USD, MSCI EM NR USD, Bloomberg Commodity TR USD, DJ US Select REIT TR USD, BBgBarc US Agg Bond 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 EMBI Global TR USD, S&P/LSTA Leveraged Loan TR.