2017 Portfolio Returns

2017 flew by. Headlines continued to be dominated by Trump, Bitcoin, and marijuana stocks, while the market as a whole steadily chugged along. Steadily enough for the S&P 500 to post a perfect year – a full year with not a single negative month (in USD). Canadian and International indexes did post some negative months, but completed a great year overall. Even bonds pulled their weight despite ever present concerns about rising interest rates.

One of the biggest impacts on portfolio returns for Canadian investors in 2017 came from the strengthening Canadian dollar. A hedged investor fared well, but don’t read too much into that – there is no reason to expect a consistent benefit from hedging. Small cap underperformed the market everywhere except for International developed. Value did not have a great year, underperforming in US and International markets, while adding only a slight edge in Canada.

The following is a breakdown of how the major asset classes that make up a globally diversified portfolio performed in 2017.

The Canadian equity market came off of a blockbuster year in 2016 – nobody can complain about 2017, either. The Canadian market (S&P/TSX Composite Index) closed out 2017 with a 9.10% return. Canadian small caps (MSCI/Barra Canadian Small Index) posted a 6.11% return, a big drop from the 27.16% gained in 2016, and Canadian value (MSCI/Barra Canadian Value Index) ended the year with a 9.49% return.

The US equity market (Russell 3000 Index) showed no signs of slowing down, posting a final return of 21.13% in USD; the strong CAD resulted in a much lower (but still respectable) 13.38% in CAD. US small caps (Russell 2000 Index) posted a return of 7.30% in CAD, and US value (Russell 3000 Value Index) finished the year with a relatively meagre return of 5.94% in CAD.

International developed equity (MSCI EAFE IMI Index – net div.) came back with a vengeance from a slightly negative showing in 2016, posting a 26.16% return in 2017 in USD; the rising CAD knocked a few points off of that, bringing the return down to 18.07% in CAD. International developed small caps (MSCI EAFE Small Index – net div.) outperformed the for the second year in a row, delivering a market-beating 24.48% in CAD, while international developed value (MSCI EAFE Value Index – net div.) dragged things back down at 13.66% in CAD.

Emerging markets (MSCI Emerging Markets Index – net div.) returned 28.48% in CAD, lifting up International equity allocations for the second year in a row. Emerging markets small caps (MSCI Emerging Markets Small Cap Index – net div.) came off of a slightly negative return in 2016 to deliver 25.26% in 2017, and emerging markets value (MSCI Emerging Markets Value Index – net div.) which returned 19.86% for the year.

Fixed income continues to prove that it should not be cast aside on account of low (and rising) interest rates. Despite interest rate increases, global bonds (Bloomberg Barclays Global Aggregate Bond Index – hedged to CAD) squeezed out a return of 2.60%. Canadian bonds (FTSE TMX Canada Universe Bond Index) posted a slightly lower 2.52% return despite two rate hikes – who would have guessed?

Between geographies, factors, and currencies, it can be hard to determine just how an overall portfolio fared in 2017. Below we will look at the 1-year return of each component of the Dimensional Fund Advisors Global Portfolios, and the 1-year returns for the components of a comparable ETF portfolio. We will then combine these components into asset allocation portfolios to compare the overall performance.

DIMENSIONAL FUNDS
DFA Canada Five-Year Global Fixed Income Fund	1.27%
DFA Canada Global Targeted Credit Fund	1.93%
DFA Canada Investment Grade Fixed Income Fund	3.50%
DFA Canada Canadian Core Equity Fund	8.19%
DFA Canada Canadian Vector Equity Fund	6.74%
DFA Canada US Core Equity Fund	10.72%
DFA Canada US Core Equity Fund (H)	17.53%
DFA Canada US Vector Equity Fund	7.60%
DFA Canada US Vector Equity Fund (H)	14.48%
DFA Canada International Core Equity Fund	21.90%
DFA Canada International Core Equity Fund (H)	21.24%
DFA Canada International Vector Equity Fund	23.26%
DFA Canada International Vector Equity Fund (H)	22.90%
DFA Canada Global Real Estate Securities Fund	1.44%

VANGUARD AND ISHARES ETFS
iShares Canadian Short Term Bond ETF	-0.07%
Vanguard FTSE Canada All Cap ETF	8.42%

VANGUARD AND ISHARES ETFS
Vanguard US Total Market ETF	13.06%
iShares Core MSCI EAFE IMI ETF	17.69%
iShares Core MSCI Emerging Markets IMI ETF	27.68%

Portfolio Performance Comparison

EQUITY/FIXED INCOME	DIMENSIONAL	ETFS	DIFFERENCE
100/0	13.55%	13.74%	-0.19%
80/20	11.04%	11.38%	-0.34%
70/30	9.92%	10.22%	-0.30%
60/40	8.77%	9.06%	-0.29%
50/50	7.58%	7.91%	-0.33%
40/60	6.39%	6.77%	-0.38%

Explaining the Difference

We would expect a difference in performance over most time periods when comparing a Dimensional Fund Advisors portfolio with an ETF portfolio. Dimensional intentionally adjusts the indexes that their funds track to increase their exposure to small cap, value, and highly profitable stocks compared to a market cap weighted index. This is done based on the academic and empirical evidence pointing to these types of stocks having higher expected returns. The equity portion of the Dimensional Global Portfolios is partially currency hedged, while most ETF model portfolios (including the ones assessed here) do not include hedging. Hedging is likely to result in a difference each year, but should not have a meaningful long-term impact. Some other structural aspects of the portfolios would be expected to have a meaningful long-term effect.

Canadian small cap stocks in general, and small cap value stocks in particular, lagged large cap stocks by a large margin. Canadian large cap growth stocks returned 12.17% in 2017, while Canadian small cap value stocks returned 2.80%. The S&P/TSX Composite is made up of 21% large cap growth stocks and 5% small cap value stocks, while the Dimensional Canadian equity allocation consists of 8% large cap growth stocks and 16% small cap value stocks. The tilt away from large cap growth and toward small cap value resulted in the Dimensional Canadian equity allocation underperforming the market index by 0.94%.
One of the strongest performing US equity components in 2017 was large cap growth stocks, while the worst performer was small cap value stocks. The Russell 3000 index consists of 21% large cap growth stocks and 5% small cap value stocks while the Dimensional US equity allocation consists of 8% large cap growth stocks and 14% small cap value stocks. Before hedging, the Dimensional US equity allocation underperformed the Russell 3000 by 3.24%. The partial hedge built into the portfolio brought the Dimensional US equity return up to 12.54%, for performance that trailed the market index by 0.84%.
International small and mid cap stocks outperformed International large cap stocks by a significant margin. The MSCI EAFE + EM index is made up of 83% large cap stocks, while the Dimensional International allocation consists of 50% large cap stocks. The additional small and mid cap exposure paid off in 2017, resulting in an additional 2.46% in returns over the market index.

The long-term evidence that small cap, value, and high profitability stocks should produce higher returns will not show up in stock returns every year, but it is still the most sensible way to allocate assets. It is also worth noting that the Dimensional Global Portfolios are rebalanced on a daily basis while an ETF portfolio would be rebalanced less frequently. Less frequent rebalancing could have either a positive or negative effect on performance.

Longer term performance for the Dimensional Global Portfolios can be seen at the PWL Ottawa model portfolios page.