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Investing Recipe for Physician Riches

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The Small Cap – Value Equity Hybrid Model?

[By Staff Reporters]

Modern physician-investors are aware of the financial research that suggests a “small-firm effect,” which shows that stocks of smaller companies may outperform both large firms and the overall market. This seems true, in a stable economy, even after adjusting for the additional risk. The Research also supports buying inexpensive, out-of-favor companies whose returns also significantly exceed the overall market. But, how about combining the two strategies to turbo-charge returns in the modern unstable era?

The Initial Thesis

This was the thesis of an article by Lawrence Creatura and Alyssa Ehrman, entitled “Finding Treasure in Small-Cap Value Stocks” [NAPFA Advisor, back in October 1996, pp.1-10, National Association of Personal Financial Advisors.

The authors explained how value stocks are created by money managers driven by clients to focus on stocks currently in favor and by investors failing to recognize a difference between a “good company” and a “good stock.” Of course, the stock of many good companies is down today, and researchers have demonstrated that “star companies” have underperformed a portfolio of “un-excellent” companies with virtually the same level of risk by some 11% per year; until now!

Small Cap Stocks

Small-cap stocks tend to be undervalued because generally Wall Street does not bother monitoring them and, accordingly, broadcasting positive events to potential investors. Also, managers of large portfolios are virtually excluded from the small-cap stock market because of the minor effect they could have on those portfolios. Most investors tend to shy away from small stocks that trade less frequently than large stocks and which can cause a lack of liquidity; or exacerbate same today.

Small Cap – Value Hybrid

Research on combining the disciplines of small-cap stock investing and value stock investing is still in its infancy. Of particular note is the Fama/French study conducted in 1992, which showed that small, low price-to-book value stocks outperformed larger, higher valued counterparts from 1963 to 1990. They also concluded that size and value do a better job of explaining variation in stock returns than more traditional methods. The authors expanded on the simplistic price-to-book ratio used to identify value stocks by weeding out firms with symptoms of financial weakness. By so doing, they were able to generate annual returns during 1976–1994 in the 18–27% range.


All of the above is fine, but what about today? Investing in small, unknown companies selling at discount valuations is not for every physician-investor. But, the potential returns may be worth the effort – and only time will tell.


What do you think? Let us know what’s on your mind with a post, opinion or comment. Is this really a recipe for success, or investing failure? And, feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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6 Responses

  1. Wall Street Analysts

    When was the last time you recall a Wall Street analyst issue a sell recommendation?
    In a WSJ review, I just learned that at the very top of the market, they told us investors to buy or hold about 95% of the time. And, last month, the pro-stock sentiment continued, even as the deep recession continued and credit crisis exacerbated.

    Of course, the argument is that stocks will rebound, so of course it’s a good time to buy. Some observers say analysts really can’t go wrong with a “buy” recommendation, because stocks will increase in value over time. Yes, it may take a long time, but the expectation is that a share price will eventually go up.

    So, what gives?


  2. The Future?

    Although it is hard to predict the future, research on the Fama/French small cap value benchmark has performed better then the SP 500 in the last nine recessions. Some are debating if small cap or value stocks would be able to produce the same returns in today credit recessions. I have seen no indication or proof that they will not survive.

    Finding alternative strategies to super charge your portfolio, is easier said then done since these strategies have more risk; example currency arbitrage.

    Amaury Cifuentes CFP


  3. Harvard University’s Endowment Fund

    Dear Jerimiah and Amaury,

    Did you know that according to portfolio analyst Paul Kedrosky, nine of the top 10 positions in Harvard University’s endowment are now in exchange-traded funds [ETFs]?

    “With this new fondness for ETFs, is it any surprise that Harvard is shrinking the size of its investing team,” Kedrosky opined in this report.

    Link: http://blogs.moneycentral.msn.com/topstocks/archive/2009/02/12/harvard-pulls-investments-in-many-u-s-stocks.aspx

    Now, the authors above also unwittingly make an excellent point for DIY investors using ETFs and Index funds; void of any sort of financial advisor input.

    Major Smith


  4. SCVFs

    Small-cap value funds are a great addition to a portfolio. I would go further than the author and say that every physician would benefit from having this investment in his or her portfolio – a small portion for the conservative investor, and a larger portion for the long-term or more aggressive investor.

    Here are some additional variations of market sectors which can add return and/or reduce risk in a properly constructed portfolio:

    1. International small-cap value (DISVX)
    2. Emerging markets value (DFEVX)

    Brian J. Knabe MD CMP™


  5. DR. Riches

    Small Cap Value, as mentioned here, is certainly an attractive addition to most physician’s portfolios understanding that a few basic rules are followed: an investment time horizon of greater than 5 years, Small Cap Value is a part of a diversified portfolio that includes appropriate diversification in other stock/ bond classes, and an understanding that Small Cap stocks have historically more volatility than most other types of stocks.

    Rather than swinging for the fences with a couple Small Cap Value stocks in your portfolio, using a low cost ETF that hold a diversified portfolio of Small Cap Value stocks is a more prudent way to allocate to this category. Morningstar lists the largest (in terms of asset size of the fund) Small Cap Value ETF’s as:

    1. Ishares Russell 2000 Value Index (IWN)
    2. Vanguard Small Cap Value ETF (VBR)
    3. iShares S&P SmallCap 600 Value Index (IJS)

    All three of the above have .25 or less expense ratio.

    David K. Luke MIM
    Certified Medical Planner™ candidate


  6. Investing for the Long Haul?

    According to Standard & Poor’s data, total annualized return of stocks from 1926 through 2013 was 9.9 percent. With the potential for those returns, however, comes greater risk.

    Despite all the expert advice you’ll no doubt come across when researching specific stocks, there are no guarantees as to how a stock will perform; the broader market is impacted by so many forces that are uncontrollable and unpredictable — including consumer emotion, political events, and natural disasters.

    That said, long-term historical market-performance data demonstrates the potential benefit of investing in stocks. This is particularly true for long-term investors who can minimize their exposure to market volatility and avoid buying based on emotion and reacting to market downturns in a panic.



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