Our Investment Philosophy
Our vision of how investing should be done comes out of the academic world......
not the world of Wall Street.
The above statement puts us at odds with the vast majority of money managers in the investment community today. At Plancorp, we are strong advocates of the efficient market hypothesis and of Modern Portfolio Theory, and derive our investment strategies from the most current academic thinking and research. We subscribe to no investment newsletters, receive no research from any Wall Street firms and pay no attention to the daily market reports on CNBC. Much of the academic thinking today points to the fact that there is actually little to no "value-added" derived from the traditional stock picking and market timing approach still favored by most investment professionals today. Academic research instead indicates that portfolio performance is primarily the result of the asset allocation decision made.
One of the most important studies to come out of the academic community in recent years focuses on the relationship between risk and return in the investment markets.
The study, completed by Eugene Fama and Ken French, and called the Three-Factor Model, teaches us that everything we have learned about expected returns in the equity markets can be summarized in three dimensions. The first is that stocks are riskier than bonds and, consequently, have greater expected returns. In addition, among stocks, relative performance is largely driven by the second and third dimensions: small vs. large and value vs. growth. Many economists and academics believe small cap and value (financially distressed) stocks outperform their large-cap and growth counterparts because the market rationally discounts their prices to reflect underlying risk. These lower prices give investors greater upside as compensation for bearing this risk.
More specifically, just as the S&P 500 has much higher historical returns than T-Bills (it's really just the investor's reward for taking on equity risk:)...the same also holds true for small stocks vs. large stocks and for value (financially distressed) stocks vs. growth (financially sound) stocks. In each case, owning the riskier stocks (small and value) must reward the investor over time in order to attract investor money and to compensate the investor for taking additional risk. (The caveat here is that while the data shows that small and value do outperform over time, they don't outperform all the time.)
The Three-Factor Model is a seminal work...grounded in academic research, supported by intellectual underpinnings and backed by historical pricing data from the 1920's to the present...today it forms the cornerstone of our investment philosophy at Plancorp.
At Plancorp, our ultimate goal is to generate returns for our clients that add incremental expected return over and above the return of the market. We do this by "owning the market" ...investing in various asset classes around the world and then into subsets of those asset classes in an attempt to capture the return of the various equity markets around the world. We also attempt to add value by overweighting our portfolios to those segments of the market that have historically shown to produce the best returns...specifically small and value. We use a low-cost, passive investing approach in order to most effectively capture for our clients the returns that the markets offer.
For more information on the history of academic investing, see "The Evolution of Investing".