“I Love it When a Plan Comes Together!”

The first quarter of 2021 delivered strong equity returns for many investors. Global stocks rose about 4.5%.¹  US stocks, up 6% or so, fared better than foreign-developed and emerging markets, which went up roughly 3.5% and 2.25%, respectively.² Like the past few quarters, we’ve seen some dramatic variance in returns. In contrast, to last year, however, value and small stocks provided materially higher returns than growth and large stocks. Investors may recall that, in 2020, large-growth companies thrived while small-value companies rose comparatively weakly:

Thus far this year, large companies very solid returns over 6%.³ US, growth stocks – those that drove last year’s returns – eked out just under 1% return for the quarter while value stocks rose more than 11%.⁴ Small US stocks, however, more than doubled that – they went up almost 13% during the quarter.⁵ Small-value equities exploded last quarter, rising more than 21%.⁶ In the chart below we can see an emerging chasm between the two stock sectors:

What’s driving small and value returns?

When trying to explain return differences, we should always remember that it may just be random variance. Equity markets are enormously volatile; they can produce surprising results without any obvious contributing factors. As the famous economist John Maynard Keynes (likely) once said “The market can remain irrational longer than you can remain solvent.” Thus, we shouldn’t rush to provide a definite answer to what’s driving market returns. Such an endeavor can be tricky and quite fickle. Caveat aside, there appear to us three factors likely driving the small and value rally. First, small and value companies have higher expected returns than large and growth companies. Over the last century or so, investors have enjoyed more robust returns by investing in small and value stocks.⁷ Their outperformance, then, shouldn’t be a surprise. Second, analysts and investors may see the “light at the end of the tunnel.” COVID shut down large sectors of the global economy. Those shutdowns adversely impacted small and value companies much more than large and growth. Today, we have several effective COVID vaccines and parts of our economy are opening again. Such developments can spell increased opportunity for small and value companies. Investors are bidding them up in anticipation. Third, the growth rally of the 2010s may just be long in the tooth. As noted above, small and value companies do have higher expected returns over long periods of time. In any given year, however, it’s close to a coin flip whether small beats large or value beats growth. Since 2016, large-growth companies have absolutely dominated small and value companies, as depicted in the chart below. Moreover, as we noted last year, much of the returns for large-growth companies were driven by a handful of very large companies.⁸ There’s only so long a few corporations can sustain an entire economy. A turnaround was bound to happen eventually.

Is the small and value rally sustainable?

Clients and regular readers should not be surprised, but the answer is: maybe! Predicting the future is notoriously difficult because a myriad of factors combine to influence capital markets. On one hand, small and value stocks have been out of favor for so long, similar to the late 1990s, that we may indeed be on the cusp on a sustained small and value rally, like the early 2000s. On the other, any number of factors could shorten or cease the good times for value and small: problems with vaccine rollout, new COVID variants forcing us to re-close the economy, or something we have yet to even consider. Thus, we don’t recommend eschewing large and/or growth stocks. They represent an important part of the global economy and we want to get our fair share of their returns. Instead, we recommend a balanced, diversified approach: some large, some small, some growth, some value. That way, we are positioned to benefit from the next rally, wherever it might be.

Copyright © 2021 Wealth Architects, LLC

¹ Global stocks represented by the MSCI ACWI Index. Unless otherwise noted, all investment return data are from Morningstar. This essay is not meant to endorse any particular investment vehicle or strategy. Past performance does not guarantee future results.

² US stocks represented by the S&P 500 Index. Developed markets represented by the MSCI EAFE Index and emerging markets represented by the MSCI EM Index.

³ Large US companies represented by the S&P 500.

⁴ Growth stocks represented by the Russell 1000 Growth Index, value stocks by the Russell 1000 Value Index

⁵ Small stocks represented by the Russell 2000 Index.

⁶ Small‐value stocks represented by the Russell 2000 Value Index.

⁷ Source: Dimensional Funds Advisors.

⁸ Source: Wealth Architects, “Q2: Lonely at the Top,” July 2020.

Wealth Architects, LLC is an SEC-registered investment adviser; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. A copy of Wealth Architects, LLC’s Form ADV Part 2A disclosure brochure discussing our advisory services and fees is available any time by contacting us or by visiting www.adviserinfo.sec.gov.

This presentation discusses certain investment products and is being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary.

Wealth Architects, LLC (“Wealth Architects”) does not guarantee any specific outcome or profit. Any forward-looking statements or forecasts contained in the presentation are based on assumptions and actual results may vary from any such statements or forecasts. Some of the information in this presentation has been obtained from third-party sources. While Wealth Architects believes such third-party information is reliable, Wealth Architects does not guarantee its accuracy, timeliness or completeness. Wealth Architects encourages you to consult with your investment advisor prior to making any investment decision.

Wealth Architects has obtained the information provided herein from various third-party sources believed to be reliable but such information is not guaranteed. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Wealth Architects is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of Wealth Architects.

Risk Disclosure

No investment strategy can guarantee a profit or protect against a loss. Please remember that all investments carry some level of risk, including the potential loss of principal invested. Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market. The securities of small-capitalization companies are subject to higher volatility than larger, more established companies and may be less liquid.

Index Definitions Note: An investor cannot invest directly in an index.

MSCI ACWI – is a stock index designed to track broad global equity-market performance. Maintained by Morgan Stanley Capital International (MSCI), the index is comprised of the stocks of about 3,000 companies from 23 developed countries and 26 emerging markets.

MSCI EAFE – an equity index which captures large and mid-cap representation across 21 Developed Markets countries* around the world, excluding the US and Canada.

MSCI EM – Stands for Morgan Stanley Capital International (MSCI), and is an index used to measure equity market performance in global emerging markets.

Russell 1000 – A stock market index that tracks the highest-ranking 1,000 stocks in the Russell 3000 Index, which represent
about 90% of the total market capitalization of that index.

Russell 2000 – a small-cap stock market index of the smallest 2,000 stocks in the Russell 3000 Index.

S&P 500 – is a free-float, weighted measurement stock market index of the 500 large companies listed on stock exchanges in
the United States. It is one of the most commonly followed equity indices.

Definitions

Emerging Markets – An emerging market economy is the economy of a developing nation that is becoming more engaged with global markets as it grows. … Critically, an emerging market economy is transitioning from a low income, less developed, often pre-industrial economy towards a modern, industrial economy with a higher standard of living.

Designations

The Chartered Financial Analyst (“CFA®”) Designation:

The Chartered Financial Analyst (CFA) charter is a globally respected, graduate-level investment credential established in 1962 and awarded by CFA Institute — the largest global association of investment professionals. There are currently more than 138,000 CFA charterholders working in 134 countries. To earn the CFA charter, candidates must: 1) pass three sequential, sixhour examinations; 2) have at least four years of qualified professional investment experience; 3) join CFA Institute as members; and 4) commit to abide by, and annually reaffirm, their adherence to the CFA Institute Code of Ethics and Standards of Professional Conduct.

High Ethical Standards

The CFA Institute Code of Ethics and Standards of Professional Conduct, enforced through an active professional conduct
program, require CFA charterholders to:
• Place their clients’ interests ahead of their own
• Maintain independence and objectivity
• Act with integrity
• Maintain and improve their professional competence
• Disclose conflicts of interest and legal matters

Global Recognition

Passing the three CFA exams is a difficult feat that requires extensive study (successful candidates report spending an average of 300 hours of study per level). Earning the CFA charter demonstrates mastery of many of the advanced skills needed for investment analysis and decision making in today’s quickly evolving global financial industry. As a result, employers and clients are increasingly seeking CFA charterholders—often making the charter a prerequisite for employment. Additionally, regulatory bodies in over 30 countries and territories recognize the CFA charter as a proxy for meeting certain licensing requirements, and more than 125 colleges and universities around the world have incorporated a majority of the CFA Program curriculum into their own finance courses.

Comprehensive and Current Knowledge

The CFA Program curriculum provides a comprehensive framework of knowledge for investment decision making and is firmly grounded in the knowledge and skills used every day in the investment profession. The three levels of the CFA Program test a proficiency with a wide range of fundamental and advanced investment topics, including ethical and professional standards, fixed-income and equity analysis, alternative and derivative investments, economics, financial reporting standards, portfolio management, and wealth planning.

The CFA Program curriculum is updated every year by experts from around the world to ensure that candidates learn the most relevant and practical new tools, ideas, and investment and wealth management skills to reflect the dynamic and complex nature of the profession.

The CERTIFIED FINANCIAL PLANNER™ Designation:

CFP® and federally registered CFP (with flame design) marks (collectively, the “CFP® marks”) are professional certification marks granted in the United States by Certified Financial Planner Board of Standards, Inc. (“CFP Board”). The CFP® certification is a voluntary certification; no federal or state law or regulation requires financial planners to hold CFP® certification. It is recognized in the United States and a number of other countries for its (1) high standard of professional education; (2) stringent code of conduct and standards of practice; and (3) ethical requirements that govern professional engagements with clients. Currently, more than 71,000 individuals have obtained CFP® certification in the United States.

To attain the right to use the CFP® marks, an individual must satisfactorily fulfill the following requirements:
• Education – Complete an advanced college-level course of study addressing the financial planning subject
areas that CFP Board’s studies have determined as necessary for the competent and professional delivery of
financial planning services, and attain a Bachelor’s Degree from a regionally accredited United States college or
university (or its equivalent from a foreign university). CFP Board’s financial planning subject areas include
insurance planning and risk management, employee benefits planning, investment planning, income tax
planning, retirement planning, and estate planning;
• Examination – Pass the comprehensive CFP® Certification Examination. The examination includes case studies
and client scenarios designed to test one’s ability to correctly diagnose financial planning issues and apply
one’s knowledge of financial planning to real world circumstances;
• Experience – Complete at least three years of full-time financial planning-related experience (or the equivalent,
measured as 2,000 hours per year); and
• Ethics – Agree to be bound by CFP Board’s Standards of Professional Conduct, a set of documents outlining
the ethical and practice standards for CFP® professionals.

Individuals who become certified must complete the following ongoing education and ethics requirements in order to maintain the right to continue to use the CFP® marks:

• Continuing Education – Complete 30 hours of continuing education hours every two years, including two hours
on the Code of Ethics and other parts of the Standards of Professional Conduct, to maintain competence and
keep up with developments in the financial planning field; and
• Ethics – Renew an agreement to be bound by the Standards of Professional Conduct. The Standards
prominently require that CFP® professionals provide financial planning services at a fiduciary standard of care. This means CFP® professionals must provide financial planning services in the best interests of their clients. CFP® professionals who fail to comply with the above standards and requirements may be subject to CFP Board’s enforcement process, which could result in suspension or permanent revocation of their CFP® certification.