2018 Portfolio Returns

Another year under the belt. 2018 seemed to mirror 2017 in the news headlines. Trump, Bitcoin, and marijuana stocks were top of mind for much of the year, with the addition of trade agreements (or a lack thereof), and a dash of market volatility that had been missing in 2017. Rising interest rates hurt fixed income returns, while stock markets around the world declined a meaningful amount. 2018 set a record for the number of asset classes experiencing losses concurrently. There was nowhere to hide.

Stock returns were negative in Canadian, US, and International markets for the calendar year. A falling Canadian dollar helped to buoy an unhedged globally diversified portfolio for a Canadian investor, but even then, it was unlikely to escape an overall negative return for the year.

The following is a breakdown of how the major asset classes that make up a globally diversified portfolio performed in 2018.

The Canadian market shed the gains from 2017 by posting a negative 8.89% return for the 2018 year. Canadian small caps (MSCI/Barra Canadian Small Index) posted a negative 12.40% return, and Canadian value (MSCI/Barra Canadian Value Index) ended the year with a negative 10.17% return.

The US equity market (Russell 3000 Index) posted its first negative calendar-year return since 2008 with a negative 5.24% return; the falling CAD resulted in a more palatable (but still disappointing) 2.92% in CAD. US small caps (Russell 2000 Index) posted a return of negative 3.35% in CAD, and US value (Russell 3000 Value Index) finished the year with a slightly negative return of 0.71% in CAD.

International developed equity (MSCI EAFE IMI Index – net div.) dropped like a rock, but the falling CAD again came to rescue for a Canadian investor; the index posted a negative 7.03% return in CAD for the year. International developed small caps (MSCI EAFE Small Index – net div.) broke from a five-year market-beating trend to post a negative 10.82% return in CAD, while international developed value (MSCI EAFE Value Index – net div.) also trailed the market with a return of negative 7.44% in CAD.

Unlike the previous two years, emerging markets (MSCI Emerging Markets Index – net div.) were a drag on International equity performance, posting a return of negative 7.22% in CAD. Emerging markets small caps (MSCI Emerging Markets Small Cap Index – net div.) were no help, posting a negative 11.59% return, and emerging markets value (MSCI Emerging Markets Value Index – net div., while less negative, still posted a negative 3.05% return.

As global interest rates rise, global bonds (Bloomberg Barclays Global Aggregate Bond Index – hedged to CAD) have felt the price pressure, returning a meagre 1.06%. Canadian bonds (FTSE TMX Canada Universe Bond Index) posted a slightly higher 1.41% return despite three rate hikes.

Between geographies, factors, and currencies, it can be hard to determine just how an overall portfolio fared in 2018. Below we will look at the 1-year return of each component of the Dimensional Fund Advisors Global Portfolios to get a feel for where the returns came from.

DIMENSIONAL FUNDS
DFA Canada Five-Year Global Fixed Income Fund	0.97%
DFA Canada Global Targeted Credit Fund	0.00%
DFA Canada Investment Grade Fixed Income Fund	0.07%
DFA Canada Canadian Core Equity Fund	-12.04%
DFA Canada Canadian Vector Equity Fund	-14.89%
DFA Canada US Core Equity Fund	-1.53%
DFA Canada US Core Equity Fund (H)	-10.35%
DFA Canada US Vector Equity Fund	-5.92%
DFA Canada US Vector Equity Fund (H)	-14.31%
DFA Canada International Core Equity Fund	-8.44%
DFA Canada International Core Equity Fund (H)	-12.13%
DFA Canada International Vector Equity Fund	-10.00%
DFA Canada International Vector Equity Fund (H)	-13.57%
DFA Canada Global Real Estate Securities Fund	3.44%

Equity Returns Attribution

We would expect a difference in performance over most time periods when comparing a Dimensional Fund Advisors portfolio with a market cap weighted index. 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 suggesting that these types of stocks have higher expected returns. The equity portion of the Dimensional Global Portfolios is partially currency hedged. Hedging is likely to result in a difference each year, but should not have a meaningful long-term impact.

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 3.00% in 2018, while Canadian small cap value stocks returned -22.98%. The S&P/TSX Composite is made up of 18% large cap growth stocks and 6% small cap value stocks, while the Dimensional Canadian equity allocation consists of 6% large cap growth stocks and 17% 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 3.70%.
One of the strongest performing US equity components in 2018 was large cap growth stocks, while the worst performer was small cap value stocks. The Russell 3000 index consists of 22% large cap growth stocks and 5% small cap value stocks while the Dimensional US equity allocation consists of 8% large cap growth stocks and 15% small cap value stocks. Before hedging, the Dimensional US equity allocation underperformed the Russell 3000 by 5.85% before hedging is accounted for. The partial hedge built into the portfolio brought the Dimensional US equity return down to 9.69% below the Russell 3000 (USD) return.
In 2017, International small and mid cap stocks outperformed International large cap stocks by a significant margin. The same was not true in 2018. The MSCI EAFE + EM index is made up of 23% large cap growth stocks, which were the best (least negative) component of International equity returns, while the Dimensional International allocation consists of 7% large cap growth stocks. The additional small and mid cap exposure was detrimental this year, resulting in returns trailing the index by 2.19% before hedging. With the partial hedge taken into account, Dimensional underperformed the index by 4.16%.

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; that does not make the strategy questionable. It is still the most statistically reliable approach to allocating assets.

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