The original investment portfolios we offer are the fully diversified portfolios with tilts to small and value companies along with other factors[1] such as profitability and momentum.  To achieve these tilts, we reallocate a portion of the funds away from large growth companies to small and value companies.  These portfolios have over 9,000 companies in them.  Diversification has been taken to the maximum here. 

The second stream of investment portfolios we operate are screened for socially responsible investment themes[2]. We call them our SRI portfolios. Because the socially responsible screens are so dominant, we were not able to include our traditional tilts to small and value companies very well. These screened portfolios are still considered well-diversified although they have considerably fewer companies (up to 4,200, depending on the mix) than our original portfolios.

Our SRI portfolios include a standard allocation to the larger growth companies that are doing so well lately. 

How have these two quite different themes performed over the past year?

Here are the returns for the first of our portfolio themes which have the ‘factor’ tilts:

Wow! It has been a great three months but what has gone wrong over the past year or two? Something not-so-good is going on?

Let’s look at the second of our two portfolio types, with the socially responsible theme:

Again, a great last quarter, and a great result over the longer term too. The socially responsible portfolio has outperformed our ‘factor’ portfolio by 7.8% over the past year and 2.5% per annum over the past five years.

When we introduced our socially responsible portfolios in early 2019, we warned investors that they had a lower expected return than our traditional ‘factor’ portfolios!

It shows how wrong these forward-looking expectations can be over the short term.

Why has our socially responsible portfolio done so well and our ‘factor’ tilted portfolio so badly?

• The bigger, more expensive growth companies are growing faster than the smaller, less expensive value companies on the share market over the past few years. This is contrary to our long-term expectations based on long-term research.
• Investors are paying a lot more for the bigger technology growth companies which have become expensive (SRI portfolios), than they are for the traditional industrial ‘value’ companies that have now become relatively cheap (‘factor’ portfolios).
• Our socially responsible portfolios have a higher allocation to New Zealand shares, and they have been the best performing sector over the past year, three years, five years, and ten years.
• Our socially responsible portfolios have no allocation to emerging market shares which have been the worst performing sector over the three and ten years (although emerging market shares beat Australian shares over the past year and five years).

Out of interest, Australian shares were the best performer over the past three months at 20.8%, hedged international shares second at 18.2% and New Zealand shares third at 16.9%.

Should investors be switching to SRI portfolios?

When you look at these past returns, I am sure there are investors who wish they had been in the socially responsible portfolios instead of the ‘factor’ portfolios. There will be some investors who think that they should swop from their ‘factor’ tilted portfolio to the socially responsible ones.

Our advice is to stick with your plan and only swop to the socially responsible mixes if your values are strongly aligned to the SRI portfolio screens.

We asked all our clients if they wanted to migrate to the socially responsible portfolios at their annual progress reviews over the past year and a half and I suspect those that wanted the SRI themed portfolios already have it.

Our advice is not to make these sorts of decisions based on short-term past returns. Bet your bottom dollar, if you changed for the wrong reason, you would find the opposite impact on your returns than we have seen over the past few years.

We know from bitter experience that the past five years’ returns are not a good indicator of the next five years’ returns. Never chase past returns.

Also, if you left the ‘factor’ tilted portfolio now to go to an SRI portfolio you would be leaving a portfolio that is undervalued and buying into a portfolio that is currently fair value or perhaps a little expensive, if you see the large technology companies as expensive at the moment.

We expect value companies to come back into favour at some stage, just like they did in 2001 when the dot.com bubble burst. Back then investors had been investing in technology companies for five or six years without paying too much attention to underlying value and it all came crashing down. This is a different time and technology is playing a bigger role in our lives, but if you can guarantee anything in markets it is that from time to time, investors get carried away with what appears to be the obvious trend of the times.

If in doubt, talk to your adviser. We love having these conversations with you.

1. By factors we mean the tilts to small and value companies that traditionally out-perform over the longer term, as well as other factor tilts such as highly profitable companies and momentum. Noble prizes have been won for this body of research.
2. Eliminating tobacco, controversial weapons including nuclear weapons, greenhouse gas emitters, child labour, alcohol, pornography, gambling and factory farming and emphasising companies involved in positive environmental, social and governance activities.