Morningstar - Q2 2023 - 11

EXHIBIT 2
consumer staples and healthcare providers.
Stocks from those sectors typically end
up in dividend-paying funds, such as Vanguard
Dividend Growth VDIGX.
But Vanguard Dividend Growth did not make the
all-weather club. Nor did any other fund that
favors either high dividends or blue chips. Quite
the contrary. The five champions each invest
primarily in companies that pay modest or no
dividends and that lie outside the S&P 500.
What's more, those companies, while established,
do not boast high scores for Morningstar's
measure of business safety (economic moats) or
its measure of financial health. Consequently,
their stocks are cheap.
As EXHIBIT 2 shows, the all-weather winners
stand out from the mainstream. Across the
board, they differ from Vanguard Total Stock
Market Index. Each of the five all-weather funds
is sponsored by a niche organization. The
funds have relatively few shareholders, and their
performances are driven by small to midsize
companies that sell at low price multiples.
Predictably, their expense ratios also sharply
exceed that of the index fund.
This result conforms with the predictions
of academic finance, which for 40 years has
claimed that both small companies and
value stocks offer a return premium. In recent
years, though, researchers have noted
the seeming disappearance of the size and
value effects, leading to articles such as
" Is Small-Cap Value Dead? " by Larry Swedroe
at Buckingham Strategic Wealth and
" Do Value Stocks Really Outperform Growth Stocks
Over the Long Run? " by Rob Berger, host
of the Financial Freedom Show. The all-weather
winners, to their credit, bucked the trend.
Granted, there's much to like about dividendgrowth
funds. On average, U.S. equity funds
that have the word dividend in their names
have matched the stock market's 21-year returns
before expenses while trailing only modestly
after costs are considered. Their risk, as measured
both by standard deviation and bear-market
results, has been slightly lower. Those funds have
been fine.
All-Weather Champions Only these five funds both outperformed the market from
2002 to 2022 and fell less than 70% as far in 2002, 2008, and 2022.
Fund
FMI Common Stock FMIMX
Heartland Value Plus HRVIX
Royce Small-Cap Special Equity RYSEX
Tributary Small Company FOSCX
Northern Small Cap Value NOSGX
Vanguard Total Stock Market
Source: Morningstar Direct. Data as of Dec. 31, 2022.
Market Cap $B
5.02
1.86
1.44
2.59
2.11
105.30
Price/Book
2.12
1.63
1.47
1.92
1.22
3.17
Expense %
1.01
1.15
1.20
1.18
1.00
1.14
Annlzd Ret %
2002-22
9.67
9.27
8.71
8.51
8.39
8.17
Total Assets
$B
1.10
0.40
0.80
0.70
1.70
1,152.90
However, the most successful all-weather
funds walk where others have feared to tread.
Their rivals' reluctance is understandable.
Small-value funds can languish for long bullmarket
stretches, as during the late 1990s and
then again two decades later. Those times
are intensely frustrating. (Perhaps even worse
for investors than suffering outright losses
is watching while others score fat profits.)
Such lulls, along with unfavorable publicity, have
limited the amount of assets in small-value
funds-especially, as we have seen, among
the all-weather winners.
Small Value's Victory
As all five of the all-weather winners hold
small-value stocks, one might wonder
how much of their accomplishment is owed
to managerial insight, as opposed to
being in the right place. (When asked about
his investment secret after his fund topped
1990's charts, Michael Gordon replied,
" I run the only biotechnology fund. " ) Perhaps
owning a small-value index fund would
have sufficed.
Indeed, it would have. On average, small-value
index funds gained half a percentage point
more per year than did the overall stock market for
the 21 years from 2002 through 2022. What's
more, although their bear-market performances
were not quite as spectacular as those of the
all-weather funds, small-value index funds did fare
much better than the mainstream index funds
when the bears arrived.
While heartening for small-value devotees, this
outcome does require two considerations.
First, the selected period could be accused of
favoring small-value stocks. After all, they
thrashed blue chips both in 2002 and 2022. While
correct in spirit-cherry-picking time periods
is an unscrupulous analyst's best ally-the
argument is dubious, because small-value stocks
also excelled before the study began, in 2000
and 2001. Also, the stock market's return after
inflation over that 21-year period resembled
its longer-term average. In that sense, the period
was representative.
The other objection is stronger. Over the full
period, small-value index funds were more volatile
than their blue-chip rivals. That argument
is not entirely convincing, because small-value
index funds better protected shareholders
during the worst of times, but the math cannot
be disputed. According to customary financial
theory, small-value index funds provided
no free lunch because they paid for their higher
returns with extra volatility.
Nevertheless, by any reasonable standard,
small-value index funds thrived. Even as growth
stocks sparkled-along with the late '90s,
the five-year period from 2017 through 2021 was
the strongest growth-stock climate of the past
half century-small-value index funds persevered.
Small-value stocks entered this century with
the best track record among U.S. equities and
quietly continued to succeed. In this instance,
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https://www.morningstar.com/funds/xnas/vdigx/quote https://www.morningstar.com/funds/xnas/vdigx/quote http://www.morningstar.com/products/magazine
Morningstar - Q2 2023

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