The Terrific Tens: High Returns and Low Risk

Article The Terrific Tens: High Returns and Low Risk

 2010-2019 saw the longest and most steady global bull market ever  US stocks outperformed those of the rest of the world in all sectors  Growth outperformance seen in the 2010s is unique over the past 80 years

The aim of this paper is simple: we look back at the decade that was. We refer to the 20102010----20192019 period as the ‘Tens’. This has been a decade in which we experienced the longest bull market on recorrecord,d, as investors kept climbing the wall ofofof worry in the aftermath of the Great Financial CrisisCrisis.... At the start of 2010, aafterfter the worst market cccrashcrash since the 1930s, most investors could only dream of the returns seenseenseen overoverover the past ten yearsyears.... The decade has been a ‘terrific‘terrific’’’’ one, as global markets rose by an annual 10% on averageaverage....

The past decade also saw the rise of FAANG and BAT stocks 1. American stocks outperformed all other regions by a wide margin. Growth outperformed value. Most importantly, both equity and bond markets rose, leading to attractive returns for all balanced portfolios. As equity market volatility was low and returns were high, the resulting return/risk ratio was strong, especially for US stocks. Article This paper consists of two parts. For professional investors February 2020 The first part discusses the developments seen in financial markets over the past decade, looking at performance across Jan Sytze Mosselaar – Portfolio Manager regions, countries, sectors and individual stocks. It also looks Pim van Vliet - Head of Conservative at the performance of popular factor indices. Equities In the second part, we look at the past decade from a longer- term perspective. We drill deeper into factor performance and compare the ‘tens’ with eight other decades going back to the 1930s. Moreover, we compare the factors on a risk-adjusted basis, allowing an apples-to-apples comparison.

1 The popular acronyms to group Facebook, Apple, Amazon, Netflix, Google, and Baidu, Alibaba and Tencent.

Part 1: Equity market performance

Region, country and sector performance

Figure 1 shows the main outcomes for global equity investors over the past decade. The US market outperformed all other regions by a wide margin. Although the 21 st century is often referred to as the Asian century, stock market developments of the past decade did clearly not reflect this.

Figure 1 I Regional equity market performance 2010-2019 (local returns)

380 2010-2019 Return Risk Return/Risk S&P 500 12.9% 14.0% 0.92 350 MSCI World 10.3% 13.2% 0.78 S&P 500 MSCI Europe 7.3% 14.8% 0.50 320 MSCI Europe MSCI AC Asia Pacific 7.2% 13.7% 0.53 MSCI Emerging Markets MSCI Emerging Markets 6.2% 13.5% 0.46 290 MSCI AC Asia Pacific

260

230

200

170

140

110

80 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Source: Bloomberg, Robeco. Local, total returns.

Not only did global and US markets generate high returns, but volatility also remained rather low, shown in Figure 2. For example, the US market did not experience any single 20% drawdown over the past decade, although the S&P 500 index came close to such a nosedive in the second half of 2018.2 A year earlier, in Q4 2017, the market volatility had reached an all-time low, as the S&P 500 index hit a 1-year realized volatility of 5.6% at the end of that year.

Figure 2 I Rolling 1-year realized volatility in % for the S&P 500 (weekly data)

Source: Robeco, Bloomberg, S&P.

2 The S&P 500 dropped 20.06% from its intraday high on Sep 21, 2018. However, based on market closing prices, the decline was 19.78%.

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Moving on to a more granular analysis, Table 1 shows that, besides the US, only the Dutch market was able to achieve double-digit returns. This was mainly due to the stellar performance of chip maker ASML, which rose by 250% over the past decade, and whose weight in the MSCI Netherlands rose from 5% to almost 19%. Meanwhile, the Spanish and Italian markets posted disappointing returns of 1.2% and 2.4% respectively, mainly due to the weak performance of banking stocks, as both markets rely heavily on financials. The sector has a 29% weight in the MSCI Italy index and a 34% weight in the MSCI Spain index. In the appendix, we show the annualized performance of the main stocks included in the MSCI World (per sector) and in the MSCI Emerging Markets Index (per country).

Table 1 I 10-year MSCI country and sector returns DM Countries Return Risk Return/risk DM Sectors Return Risk Return/risk

United States 12.9% 14.0% 0.92 Consumer Staples 10.5% 10.2% 1.03 Netherlands 10.9% 16.6% 0.66 Health Care 12.8% 12.9% 0.99 Australia 7.6% 13.6% 0.56 Information Technology 15.8% 16.3% 0.96 Switzerland 7.7% 14.3% 0.54 Consumer Discretionary 13.8% 14.6% 0.95 United Kingdom 7.1% 14.0% 0.51 Real Estate 11.7% 13.6% 0.86 Hong Kong 8.2% 16.2% 0.51 Industrials 11.0% 15.3% 0.71 Canada 5.8% 12.3% 0.47 Communication Services 8.5% 12.4% 0.68 Japan 8.2% 18.4% 0.45 Utilities 6.9% 11.4% 0.61 France 7.6% 17.5% 0.43 Financials 8.2% 16.3% 0.51 Germany 7.8% 18.2% 0.43 Materials 5.0% 17.2% 0.29 Spain 1.2% 22.3% 0.05 Energy 2.3% 18.6% 0.12

EM Countries Return Risk Return/risk EM Sectors Return Risk Return/risk Thailand 10.6% 19.1% 0.55 Information Technology 12.2% 19.9% 0.61 Taiwan 8.3% 18.1% 0.46 Consumer Staples 5.1% 14.8% 0.35 China 5.3% 20.8% 0.26 Health Care 5.0% 17.2% 0.29 South Korea 5.2% 21.2% 0.25 Consumer Discretionary 5.2% 20.0% 0.26 Indonesia 5.2% 22.9% 0.23 Real Estate 4.7% 18.3% 0.26 Malaysia 2.9% 14.7% 0.20 Financials 3.5% 19.0% 0.19 India 3.9% 19.5% 0.20 Communication Services 0.9% 14.6% 0.06 Russia 4.2% 27.9% 0.15 Energy 0.7% 22.0% 0.03 South Africa 2.9% 26.4% 0.11 Industrials -0.1% 18.4% -0.01 Mexico 1.1% 21.8% 0.05 Utilities -0.3% 15.2% -0.02 Brazil -0.9% 29.2% -0.03 Materials -1.7% 21.0% -0.08

Source: Robeco, Bloomberg, MSCI. Developed markets in local returns, emerging markets in USD returns.

Maybe surprisingly, Information Technology did not show the highest return/risk ratio in developed markets, as both the Consumer Staples and Health Care sector achieved a lower risk level.

The strong outperformance of US stocks can, to a large extent, be explained by rise of the large technology-related stocks such as Apple, Microsoft, Amazon and Google’s Alphabet. This has been and remains the ‘age of the FAANGs’. However, looking at market capitalizations, it makes more sense to take Microsoft into the equation as well, as the revived software developer ended the decade as America’s second most valuable company, after Apple, with a USD 1.2 trillion market capitalization (versus USD 1.3 trillion). 3

But this is just one part of the story. Table 2 shows how each of the 11 GICS sectors contributed to the performance of both the S&P 500 and the MSCI EAFE indices (representing 21 developed countries but excluding the US and Canada). Remarkably, the selection effect has been positive for the US in all sectors, meaning that the average (market cap-weighted) US stock did better than the average non-US stock in every sector. This shows how broad the outperformance of American stocks has been.

3 Aramco is now officially the world’s most valuable listed company with a USD 1.87 trillion market capitalization. However, its free float is only 1.5%.

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Table 2 I Performance attribution S&P 500 vs MSCI EAFE Index (2010-2019)

% Average Weight Total Return (%) Total Attribution Allocation Selection Currency S&P 500 MSCI EAFE+/- S&P 500 MSCI EAFE +/- 100.0 100.0 0.0 253 81 173 172.6 20.9 109.5 42.2 Information Technology 17.3 4.8 12.5 401 142 259 37.9 11.8 24.2 1.8 Financials 13.7 20.7 -7.0 207 37 170 35.6 5.3 21.1 9.2 Communication Services 8.8 6.5 2.3 344 71 273 18.2 -2.8 18.0 3.0 Health Care 13.7 10.3 3.4 292 149 143 17.2 3.4 9.9 3.9 Consumer Discretionary 8.6 10.7 -2.0 379 130 248 15.7 -0.9 12.0 4.6 Industrials 10.0 13.3 -3.2 251 119 132 11.8 -1.1 7.8 5.1 Materials 3.2 8.4 -5.2 139 39 100 10.4 4.1 3.2 3.1 Consumer Staples 9.2 10.9 -1.7 212 127 85 8.6 0.5 3.5 4.6 Utilities 3.2 4.0 -0.8 200 28 171 8.4 1.4 5.1 2.0 Real Estate 2.5 3.4 -0.9 256 88 168 3.7 0.2 2.2 1.3 Energy 8.7 6.4 2.2 37 22 15 3.6 -1.0 0.9 3.7 Not Classified 1.2 0.9 0.3 109 79 30 1.7 0.5 1.5 -0.3

Source: Bloomberg PORT. All figures in USD.

Table 2 also shows that the good performance of US tech companies explains a significant part of the outperformance of the S&P 500 index: 38 percentage points of the 173% performance gap. Not only did the larger weight of tech companies in the S&P 500 index contribute positively, but the selection effect also had a positive impact within that sector.4 Thus, the US stock market profited from a higher weight of IT stocks, but more importantly the US IT stocks outperformed non-US IT stocks. In this analysis, companies are classified according to the new GICS sector classification that is live since the fall of 2018, which moved some of the FAANG stocks out of the Information Technology sector, thereby understating the effect of that sector. 5

Despite a strong US tech performance, the largest part of the performance gap between both indices is non-tech related. US stocks outperformed non-US stocks in each and every sector. The selection effect was positive for Energy, Materials, Utility, Consumer, Communication, Industrials, Health Care, Real Estate, Health Care, Real Estate and Financials stocks, no exceptions. For example, a significant difference has been the better performance of American versus European banks. Many European banks were hit by the European debt crisis in 2011, as well as by a troubled episode in 2015. Table 3 compares the annualized stock price performance of the 10 largest European and American banks, as measured by their balance sheet, over the 2010-2019 period.

Table 3 I 10-year annualized performance largest European and US banks (by total assets)

Europe 10yr return United States 10yr return HSBC 3.5% JP Morgan 15.6% BNP Paribas 3.7% Bank of America 10.0% Crédit Agricole 4.2% Citigroup 10.1% Banco Santander -4.0% Wells Fargo 10.0% Deutsche Bank -14.3% Goldman Sachs 4.6% Société Générale -0.9% Morgan Stanley 7.3% Barclays -1.0% U.S. Bancorp 12.7% Lloyds Banking Group 4.4% PNC Financial Services 14.2% ING Groep 7.0% Bank of New York Mellon 8.1% UBS Group -0.2% Capital One 11.9%

Source: Bloomberg, Robeco. Local total returns as calculated by Bloomberg.

4 Admittedly, with the large index weights of Apple and Microsoft in the sector, allocation and selection effects become entangled. 5 If we add Google’s Alphabet (+5), Amazon (+6), Netflix (+1.3) and Facebook (+3.6), the contribution increases to 54 percentage points, or roughly a third of the performance difference between the US and the EAFE Index.

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Factor index performance

Next, we take a look factor style performance to further study the 2010s. Table 4 shows the 10-year risk and return of several generic factor indices for which we use the publicly available MSCI definitions. Results are shown for global, emerging, US and European markets. Generally speaking, low volatility experienced the best decade, offering the highest return per unit of risk. This was the case in global markets, US markets and EM markets but not in Europe. In Europe, momentum was the winner, both in terms of absolute and risk-adjusted returns, followed by the low-volatility factor. Moreover, momentum achieved the highest absolute return in other regions. In all regions, value posted the lowest return and also the lowest return per unit of risk. For value investors, this decade can probably better be described as the ‘terrible tens’ instead of the ‘terrific tens’.

Table 4 I Risk/return factor indices 2010-2019 Return Risk Return/risk Return Risk Return/risk Global Minimum Volatility 9.7% 9.7% 1.00 EM Minimum Volatility 5.9% 13.2% 0.45 Global Value-weighted 8.2% 14.6% 0.56 EM Value-weigthed 3.1% 18.2% 0.17

Global Momentum 13.0% 13.9% 0.93 EM Momentum 6.7% 17.4% 0.39 Global High Dividend 8.2% 12.6% 0.65 EM High Dividend 3.4% 17.3% 0.20 Global market 9.5% 13.8% 0.69 EM market 3.7% 17.5% 0.21

Return Risk Return/risk Return Risk Return/risk Europe Minimum Volatility 7.2% 13.4% 0.54 US Minimum Volatility 13.5% 10.6% 1.27 Europe Value-weighted 3.7% 19.3% 0.19 US Value-weighted 12.3% 14.4% 0.85 Europe Momentum 9.2% 16.4% 0.56 US Momentum 15.6% 14.8% 1.05

Europe High Dividend 5.1% 16.4% 0.31 US High Dividend 13.8% 11.9% 1.16 Europe market 5.2% 17.1% 0.30 US market 12.9% 14.0% 0.92

Source: Bloomberg, Robeco.

Value / high dividend Value and high dividend investors experienced a tough decade in the ‘age of the FAANGs’, leading many people to believe that value investing might be dead. That is often the case when factors disappoint for a certain period. Narratives such as those of the ‘new economy’ in the 1990s and ‘the platform economy’ in the 2010s explain past performance. Still, the question is if these narratives also predict future performance. In the 2000s this was not the case, and no one knows what the 2020s will bring. We know that technology changes, but human behavior is pretty constant over time. This means that certain factors might not work for a prolonged period of time and causes factor performance to be cyclical. Given the large outperformance of the growth-like Information Technology and Consumer Discretionary sectors and the lagging performance of several value-like segments of the market, such as energy stocks and financial stocks, the underperformance should not come as a surprise. Figure 3 shows the large performance gap between the aforementioned sectors.

Figure 3 I Relative performance growth-like sectors (IT, Consumer Discretionary) versus value-like sectors (Energy, Financials). Rebased (31 December 2009 = 100 450

400

350 Info Tech Energy 300 Consumer Discretionary Financials 250

200

150

100

0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Source: Robeco, Bloomberg, MSCI.

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Also the high-dividend style struggled over the past decade. This is reflected in the poor performance of the MSCI World High Dividend Index. Moreover, we see a similar pattern, when we zoom in on the largest 100 names in the MSCI World (as of half-way the decade) and look at the top 20 and bottom 20 performers (Table 5). The top performers are mostly stocks with a low or no dividend, while the bottom performers are mostly cheap high-dividend stocks. Again, we see the large performance gap between growth-like technology stocks and value-like energy and financial stocks.

Table 5 I Top 20 / bottom 20 performers of the largest 100 MSCI World Index stocks 10Y return Dividend 10Y return Dividend Basf Se Materials 8.3% 4.8% Amazon.Com Inc Consumer Discretionary 29.9% 0.0% Royal Dutch Shell Plc-A Shs Energy 7.9% 6.4% Mastercard Inc - A Information Technology 28.5% 0.5% Tencent Holdings Ltd Communication Services 27.6% 0.3% Daimler Ag-Registered Shares Consumer Discretionary 7.3% 6.6% Apple Inc Information Technology 27.3% 1.0% Walgreens Boots Alliance Inc Consumer Staples 7.2% 3.1% Unitedhealth Group Inc Health Care 27.3% 1.5% Total Sa Energy 6.5% 5.4% Home Depot Inc Consumer Discretionary 25.3% 2.5% Westpac Banking Corp Financials 6.0% 7.2% Visa Inc-Class A Shares Information Technology 24.9% 0.6% Vodafone Group Plc Communication Services 6.0% 5.0% Starbucks Corp Consumer Discretionary 24.5% 1.9% Mitsubishi Ufj Financial Gro Financials 5.9% 4.2% Boeing Co/The Industrials 22.6% 2.5% Bayer Ag-Reg Health Care 5.6% 3.8% Tjx Companies Inc Consumer Discretionary 22.5% 1.5% Goldman Sachs Group Inc Financials 4.6% 2.2% Taiwan Semiconductor Manufac Information Technology 22.1% 2.4% Bhp Group Ltd Materials 3.9% 4.9% Novo Nordisk A/S-B Health Care 21.8% 2.1% Exxon Mobil Corp Energy 3.5% 5.0% Union Pacific Corp Industrials 21.4% 2.1% Hsbc Holdings Plc Financials 3.5% 6.5% Nike Inc -Cl B Consumer Discretionary 21.4% 1.0% Intl Business Machines Corp Information Technology 3.2% 4.8% Microsoft Corp Information Technology 20.7% 1.3% China Mobile Ltd Communication Services 3.2% 4.5% Comcast Corp-Class A Communication Services 20.4% 1.9% Bp Plc Energy 2.9% 6.6% Texas Instruments Inc Information Technology 20.2% 2.8% Hp Inc Information Technology 1.1% 3.4% Lowe'S Cos Inc Consumer Discretionary 19.9% 1.8% General Electric Co Industrials 0.3% 0.4% Biogen Inc Health Care 19.7% 0.0% Schlumberger Ltd Energy -2.4% 5.0% Danaher Corp Health Care 18.8% 0.4% Banco Santander Sa Financials -4.0% 6.2%

Source: Robeco, Bloomberg, FactSet. Top 100 as of half-way the decade, 31/12/2014. Current 12m trailing dividend yields

Momentum Momentum worked well in all regions over the past decade. Generally speaking, the factor benefited from a multi-year rally for growth stocks, combined with the good performance of several defensive but expensive names. Especially during the last five years, the MSCI USA Momentum and MSCI World Momentum Indices had a large weight in growth-like sectors, such as Information Technology, Health Care and Consumer Discretionary, as well as in the ‘defensive-expensive’ Consumer Staples sector. As a result, the valuation of the MSCI World Momentum has been in line with the MSCI World Growth, while the valuation gap with the value index has been widening, as we will show in the outlook section of this paper.

Low volatility The low-risk (or minimum volatility) factor performed in line with the market. This is remarkable, since the market went up by more than 10% per annum. Thus low volatility has been a strong performer on a risk-adjusted basis, leading to the highest Sharpe ratio amongst the five factors considered. In the next session, we will put this performance into a long-term perspective.

In Europe and emerging markets, low volatility generated an outright outperformance. Since these regions have been more volatile and achieved a lower return than the US market, this confirms the common view that low-volatility performs well in a more volatile market environment with overall modest equity returns.6

In the second half of the decade, the MSCI Minimum Volatility Indices profited from their anti-value or growth bias, as most low-risk stocks got quite expensive over the years. Because expensive stocks have outperformed cheap stocks in the last five years, this has been a clear tailwind for the Minimum Volatility indices.

Yearly relative factor returns Additionally, we display the annual relative factor returns in Table 6, in which we show how factor performance can fluctuate quite significantly over the years. In years of great performance for the FAANGs and the BATs, like in 2017 for example, we see that the high-dividend, value and low volatility stocks lagged, while momentum stocks outperformed. Meanwhile, in the more volatile years, like in 2011, 2015 and 2018, low-risk stocks performed well, which is consistent with our expectations.

6 This is exactly what Robeco expects for the next five years, as outlined in our award-winning Expected Returns publication, which is available here .

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Finally, 2019 was a great year for equity investors in absolute terms. Factor indices posted high absolute returns, although buying the bullish market would have been the best performing strategy last year. A ‘hidden’ variable here, not shown, is the outperformance of large caps. Because factor strategies typically have more exposure to mid-caps than large-caps, this had a negative impact on the relative performance of factor strategies in 2019.

Table 6 I Yearly relative MSCI Factor Index returns

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 10YR Global Minimum Volatility -0.3% 10.0% -7.2% -11.3% 3.3% 5.8% -0.4% -3.2% 5.0% -4.3% 0.2% Global Value-weighted -0.5% -3.2% 0.5% 1.2% -2.6% -3.2% 3.9% -1.0% -3.3% -3.7% -1.3% Global Momentum 4.3% 9.8% -1.7% 3.0% 1.6% 4.9% -3.3% 9.7% 5.9% 0.0% 3.5% Global High Dividend -5.5% 9.4% -3.6% -4.8% -2.5% -2.3% 1.8% -4.3% 1.2% -4.5% -1.2%

EM Minimum Volatility 10.0% 12.2% 4.0% 2.6% 3.3% 2.9% -7.3% -10.6% 8.8% -9.9% 2.2% EM Value-weigthed -0.1% -0.2% -0.1% -0.5% -4.9% -1.6% 8.0% -6.6% 2.4% -2.6% -0.5% EM Momentum 5.7% 6.5% 2.0% 6.4% 4.2% -1.1% -7.1% 11.9% -0.3% 4.6% 3.0% EM High Dividend 0.8% 6.2% 1.3% -2.0% -2.0% -6.1% 5.0% -13.7% 7.0% -2.4% -0.3%

Europe Minimum Volatility -1.1% 12.2% -4.6% -2.6% 7.9% 7.2% -6.5% -2.6% 6.9% -1.7% 2.0% Europe Value-weighted -3.6% -4.5% -0.1% 1.4% -1.5% -4.5% 5.1% 0.4% -2.3% -4.0% -1.5% Europe Momentum 12.7% 7.5% 1.3% 3.8% 2.4% 5.6% 0.5% 0.9% 0.8% 3.9% 4.0% Europe High Dividend -6.8% 9.6% -11.0% 2.0% 2.6% -0.5% 1.3% -6.5% 5.1% -0.3% -0.1%

US Minimum Volatility -0.9% 10.6% -5.1% -7.4% 3.1% 4.2% -1.1% -2.8% 5.9% -3.8% 0.6% US Value-weighted 0.1% -1.2% 1.3% 2.4% -1.0% -3.7% 5.1% -2.8% -3.5% -0.9% -0.6% US Momentum 3.0% 4.1% -1.0% 2.2% 1.6% 8.0% -6.3% 16.1% 3.0% -3.4% 2.7% US High Dividend 0.4% 12.3% -5.5% -3.7% 1.5% -0.6% 4.6% -2.4% 2.2% -9.2% 0.2%

Source: MSCI, Bloomberg, Robeco.

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Part 2: Equity factor performance across 9 decades

In this second part of the paper, we look at the performance of factor portfolios across decades. This helps us to put the last decade into a 90-year long perspective. We know that in the past decade momentum and low-volatility were the winning styles and value was the weakest factor. But how did these styles perform in other decades? Using publicly available data, we constructed a deep historical database for US equity factors. Figure 4 shows the annualized returns in excess of the 30- day T-bill rate for low volatility, momentum, value, small caps, high dividend and the market. This for the 90 year period January 1930 – December 2019. For the exact definitions of these factors see the appendix ‘Factor Construction’.

Over this full 9 decade period the low volatility factor comes out as the strongest factor. The average return is 8.0% with 15.6% risk (measured as full-sample volatility of returns). Thus low-volatility gives somewhat higher returns, with lower risk. Momentum, value and small caps have even higher returns, but with higher risk. The momentum factor comes out second, followed by high dividend, small caps and value. Especially small caps and value have shown a higher risk. High-dividend investing falls somewhere between the market and low volatility investing, which is to be expected from this investment style. All factors have shown a better risk/return ratio than the market over the past 90 years.

Figure 4 I Factor risk/return ratios 1930-2019

0.65 Return Risk Sharpe ratio Low volatility 8.0% 15.6% 0.57 0.60 Momentum 9.1% 19.8% 0.54 High Dividend 8.2% 19.7% 0.50 0.55 Small caps 9.1% 24.4% 0.48 Value 9.1% 25.5% 0.47 Market 7.5% 20.6% 0.45 0.50

0.45

0.40

0.35 Low volatility Momentum High Dividend Small caps Value Market

Source: Robeco, based on Kenneth French Database and Paradoxinvesting.com

The 2010s resembled the 1930s and the 1990s Parallels are often drawn between the 1990s and the last decade. In both periods, momentum was the strongest factor. Yet value did not struggle as much in the 1990s, outperforming the market as well as the low volatility, high dividend and small caps factors. In fact, the 2010s were much closer to the 1930s. Just like in the 2010s, the value style also came out last in the 1930s, while momentum had a strong run. Moreover, the recovery seen in the 2010s, after a severe global stock market crash, echoes the recovery of the 1930s. However, unlike the 2010s, the 1930s were characterized by low returns and high risks, an environment in which low-volatility stocks tend to perform well relative to other styles.

Interestingly, the small-cap factor tends to closely follow value in several decades. Furthermore, high dividend often performs somewhere in between value and low volatility. This was the case during the last decade, but not the case in the two previous decades. During the internet boom of the 1990s, dividends fell out of fashion, only to recover in the 2000s, when the tech bubble burst. During the 2010s, high-dividend investing slightly lagged the market, as investors focused on the FAANG-like stocks.

During the 1940s value achieved a very strong performance. Markets went up by more than 10% and low volatility lagged the market and all other factors. During this period, low volatility stocks were expensive, similar to the start of the 2020s. Already seven years ago, we wrote a paper on the performance of low volatility stocks in periods when they were more

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expensive than the market, which mostly occurred during the 1940s and 1950s.7 We argued that an enhanced low volatility strategy could protect from this kind of scenario. Today, we still make this claim.

Table 7 I Factors performance across decades 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s

Low Volatility Value Momentum Small Caps Value Low Volatility Momentum Small Caps Momentum 4.7% 18.4% 19.1% 9.2% 7.2% 12.4% 13.2% 5.3% 12.9%

Momentum Small Caps Value Value High Dividend Value Value High Dividend Low Volatility 4.2% 15.7% 18.8% 9.1% 4.7% 11.3% 11.1% 4.5% 12.8%

Small Caps High Dividend Small Caps Momentum Momentum High Dividend Market Value Market 4.2% 14.8% 16.4% 9.0% 4.1% 11.1% 9.9% 4.1% 11.5%

Market Momentum Market High Dividend Small Caps Momentum Low Volatility Low Volatility High Dividend 1.6% 14.6% 16.4% 7.0% 3.9% 9.2% 9.3% 3.6% 11.2%

High Dividend Market Low Volatility Market Low Volatility Small Caps Small Caps Momentum Small Caps 0.2% 13.0% 16.2% 6.8% 3.0% 8.1% 8.5% 2.4% 11.1%

Value Low Volatility High Dividend Low Volatility Market Market High Dividend Market Value -1.5% 11.0% 16.0% 6.3% 2.4% 8.1% 8.2% 2.2% 9.7%

Conservative Formula (rank per decade in italics)

7.9% 17.8% 20.7% 9.5% 6.9% 13.9% 9.5% 5.0% 14.1%

1st 2nd 1st 1st 2nd 1st 4th 2nd 1st

Source: Robeco, based on Kenneth French Database and Paradoxinvesting.com

Combine multiple factors: Conservative Formula To support the case for our view of the superiority of an enhanced low-volatility approach, the table also shows the results for our Conservative Formula. 8 The Conservative Formula selects low-risk stocks with a high net pay-out yield (NPY) and positive momentum, thereby resembling our Conservative Equities strategy, albeit in a very simplified manner. For more details see the book and article.

Table 7 shows how useful this selectiveness can be. For example, in the 1940s and 1950s, the low-volatility factor was an underperforming factor, following the good relative performance of low-volatility stocks in the 1930s. However, the Conservative Formula would have profited from the focus on dividend yield and momentum, thereby alleviating the relative performance pain from the low-vol factor. In fact, the Conservative Formula would have managed to comfortably beat the market, despite its focus on lagging low-vol stocks in the two decades. This perfectly illustrates the importance to be selective within the low-risk universe, and convincingly supports our real-life investment process of selecting low-risk stocks that exhibit, along with other characteristics, a high income, potential attractive valuation levels and positive momentum. For the coming decade, we expect this selectiveness to be more important than in the past decade, and especially the value factor can make a difference once it makes a comeback, an expectation we outline in the next paragraph.

So the low-volatility factor is alive and kicking, clearly showing its added value in the past decade, especially when we correct for risk. Figure 4 shows how the low volatility factor also comes out as the strongest factor over the last nine decades with the highest return/risk ratio of all factor styles. Small caps and value come out as most risky, which leads to risk/return ratios which are only slightly higher than the market’s. High-dividend investing falls somewhere between the market and low

7 Enhancing a low-volatility strategy is particularly helpful when generic low-volatility is expensive, Pim van Vliet, Robeco research paper, June 2012. 8 This formula was first presented in the book by Pim van Vliet and Jan de Koning High Returns from Low Risk , Wiley 2016. It was subsequently extensively tested in: Van Vliet P. and Blitz, D. C., 2018, ‘The Conservative Formula: Quantitative Investing Made Easy’, The Journal of Portfolio Management .

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volatility investing, which is to be expected from this investment style. All factors have shown a better risk/return ratio than the market over the past 90 years.

Outlook for the 2020s

Although the main purpose of this paper was to look back at the decade that was, we also want to share our thoughts regarding the years to come. A good starting point, in our (biased) opinion, is Robeco’s 5-year outlook. The main conclusions in terms of expected returns and risks are summarized in Table 8, which are the results of ongoing research by Robeco’s global macro team. Going forward, the team expects lower returns and normalized volatility levels, mainly based on long- term valuation and macroeconomic analyses. Developed equity markets are richly valued, especially in the US, while Robeco considers that a recession is inevitable in the next five years.

So, a repeat of the past ‘dream decade’ seems unlikely. Also, bond investors should realistically not expect the same returns they enjoyed over the past decade, given the ultra-low or even negative yield levels. Although timing factors and investment styles is difficult, we would not be surprised if high-dividend stocks would make a comeback, as yield-starved investors are looking for alternatives to bonds.

Table 8 I Robeco’s return and risk expectations

Moreover, since the 2010s were a decade for growth investors, the value factor seems to be ready for a long-awaited rebound. Timing this rebound has proven to be difficult, but the valuation discount of value versus growth stocks might be an indicator that growth stocks are starting to be expensive in comparison with value stocks: while the discount for value stocks has typically been around 20%, this has doubled to more than 40% after the past decade’s growth rally. Figure 5 illustrates this valuation gap, which is present in both the US and Europe.

10 | Article - For professional investors - February 2020

Figure 5 I Relative price earnings/ratio Value versus Growth

-5%

-10%

-15%

-20%

-25%

-30%

-35%

-40% World US Europe -45%

-50% Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19

Source: Robeco, Bloomberg. Difference in price/earnings ratio for US (Russell 1000 Value / Russell 1000 Growth), Europe (MSCI Europe Value / MSCI Europe Growth) and World (MSCI World Value / MSCI World Growth).

In addition, generic growth, momentum and low volatility stocks currently trade at a premium versus the market index, as Figure 6 shows. The valuation gap between these factors and the value and high-dividend factors have diverged significantly in the last few years. A mean reversion of this gap back to its historical average would imply a significant outperformance of value and high-dividend stocks.

Figure 6 I Price/earnings ratio main MSCI factor indices relative to MSCI World

1.7

1.5

1.3

1.1

0.9

0.7

Growth Momentum VAlue Minimum Volatility High Dividend

0.5 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20

Source: Bloomberg, Robeco. Price/earnings ratios for the main MSCI factor indices as calculated by Bloomberg, versus the MSCI World P/E.

11 | Article - For professional investors - February 2020

We want to emphasize that Robeco’s Conservative Equities strategies selects low-risk stocks with what we view as attractive valuations, leading to portfolios of stocks that trade at lower valuation levels versus the market and minimum volatility indices, as shown in Table 9. Moreover, the overlap between Conservative Equities and the MSCI Minimum Volatility Indices remains low, around 30% on average.

As such, we are confident that our strategy is well-positioned for the new decade, offering an actively positioned portfolio of attractively valued, high income low-risk stocks with positive momentum. Moreover, Conservative Equities is a patient equity strategy with a relatively low expected turnover, which is further decreased by actively using cash flows to reoptimize the portfolio.

Table 9 I Portfolio characteristics Global Conservative Equities

31-Dec-2019 Portfolio MSCI MSCI MinVol Summary

Risk 1 1

Volatility (holdings-based 3y) 18.0% 23.0% 1 18.1% 1 Lower risk than MSCI, similar to MinVol

Beta (holdings-based 3y) 0.56 1.00 1 0.45 1

Distance-to-default 8.6 6.6 1 8.3 1

Valuation 1 1

Dividend yield 3.6% 2.4% 1 2.8% 1 Higher dividend yield and better valuation than MinVol

Net payout yield 4.8% 3.1% 1 2.9% 1

Price/Earnings 15.8 18.4 1 21.2 1

Momentum 1 1

Price momentum (12-1M) 34.8% 28.6% 1 22.9% 1 Better price momentum and revisions than MinVol

Earnings revisions (3M, % net positive) 67.8% 51.3% 1 52.0% 1

Market cap 1 1

Large cap (>10 bln USD) 60.3% 90.9% 1 85.1% 1 Increased opportunity set with small and mid caps

Mid cap (<10 bln USD) 20.1% 9.1% 1 14.9% 1

% outside MSCI market index 19.6% 0.0% 1 0.0% 1

Other characteristics 1 1

Number of securities 246 3049 1 435 1 Diversified, active and more sustainable portfolio

Active share 86% - 1 74% 1

RobecoSAM ESG score 52.1 51.3 1 49.5 1

Turnover 1 1

Expected turnover 25% - 1 20% 1 Low turnover, average holding period 4 years

Realized turnover 5% 4% 1 22% 1

Source: FactSet, MSCI, Robeco. Figures are holdings-based. Base currency for optimization MSCI Minimum Volatility indices is EUR. The unbiased RobecoSAM Smart ESG scores combine Environmental, Social and Governance factors. The score depicts the percentage of stocks in the universe that have a lower sustainability profile than the portfolio. A higher score refers to a better overall sustainability. The portfolio construction process ensures that the overall sustainability score of the portfolio is better than or equal to the overall sustainability score of the index. Turnover figures are calculated one- way/annum since inception of the portfolio (based on full calendar years only). The portfolio characteristics are as of the end of the relevant period. Please refer to the appendix for other important disclosures.

12 | Article - For professional investors - February 2020

Appendix I: 10-year total returns largest stocks in MSCI World Index and MSCI EM Index

MSCI World Index

15.7% 13.8% 12.8% 10.9% 10.5% 9.4% 8.5% 6.9% 6.4% 5.0% 2.2% Information Consumer Communication Health Care Industrials Consumer Staples Real estate Utilities Financials Materials Energy Technology Discretionary Services

Apple Inc Amazon.Com Inc Johnson & Johnson Boeing Co/The Nestle Sa-Reg American Tower Corp Facebook Inc-Class A Nextera Energy Inc Jpmorgan Chase & Co Linde Plc Exxon Mobil Corp 27% 30% 12% 23% 11% 20% 24% 20% 16% 13% 4%

Microsoft Corp Home Depot Inc Pfizer Inc 3M Co Procter & Gamble Co/ Simon Property Group Alphabet Inc-Cl A Duke Energy Corp Berkshire Hathaway I Bhp Group Ltd Chevron Corp 21% 25% 12% 11% 11% 11% 16% 11% 13% 4% 9% Visa Inc-Class A Sha Mcdonald'S Corp Unitedhealth Group I Honeywell Internatio Coca-Cola Co/The Crown Castle Intl Co Verizon Communicatio Dominion Energy Inc Bank Of America Corp Basf Se Royal Dutch Shell Pl 25% 16% 27% 19% 10% 16% 12% 12% 10% 8% 8% Intel Corp Toyota Motor Corp Merck & Co. Inc. Union Pacific Corp Pepsico Inc Prologis Inc At&T Inc Southern Co/The Wells Fargo & Co Air Liquide Sa Bp Plc 15% 10% 13% 21% 12% 17% 9% 12% 10% 12% 3%

Cisco Systems Inc Nike Inc -Cl B Novartis Ag-Reg United Technologies Walmart Inc Public Storage Walt Disney Co/The Iberdrola Sa Hsbc Holdings Plc Gam Swiss Eq C Total Sa 10% 21% 10% 11% 11% 14% 18% 9% 3% 9% 7% Mastercard Inc - A Starbucks Corp Roche Holding Ag-Gen Siemens Ag-Reg Philip Morris Intern Equinix Inc Comcast Corp-Class A Enel Spa Citigroup Inc Air Products & Chemi Royal Dutch Shell Pl 28% 24% 10% 10% 11% 21% 20% 11% 10% 15% 8% Oracle Corp Booking Holdings Inc Abbvie Inc Caterpillar Inc Altria Group Inc Welltower Inc Netflix Inc Exelon Corp Royal Bank Of Canada Sherwin-Williams Co/ Conocophillips

9% 25% 19% 13% 15% 12% 45% 4% 10% 27% 9% Adobe Inc Lvmh Moet Hennessy L Abbott Laboratories Lockheed Martin Corp Costco Wholesale Cor Equity Residential Softbank Group Corp American Electric Po Aia Group Ltd Ecolab Inc Enbridge Inc 25% 22% 16% 22% 20% 14% 17% 15% 17% 17% 12% Broadcom Inc Lowe'S Cos Inc Medtronic Plc United Parcel Servic Diageo Plc Avalonbay Communitie Deutsche Telekom Ag- National Grid Plc Toronto-Dominion Ban Dupont De Nemours In Eog Resources Inc 35% 20% 12% 11% 15% 13% 9% 10% 12% 8% 6%

Source: Bloomberg, Robeco. Largest stocks per MSCI World sector as of 31/12/2014, so halfway the decade. Total local return. Stocks with less than 10- year history are measured from their IPO price.

MSCI Emerging Markets Index

Local index return 9.4% 7.6% 5.4% 5.4% 5.1% 10.5% 8.4% 4.8% 9.7% 4.9% 7.7% USD index return 10.6% 8.3% 5.3% 5.3% 5.2% 4.2% 3.9% 2.9% 2.9% 1.1% -0.9%

Thailand Taiwan China China South Korea Russia India Malaysia South Africa Mexico Brazil

Ptt Pcl-Nvdr Taiwan Semiconductor Alibaba Group Holdin Tencent Holdings Ltd Samsung Electronics Lukoil Pjsc Reliance Industries Public Bank Berhad Naspers Ltd-N Shs America Movil Sab De Itau Unibanco Holdin

10% 22% 17% 28% 15% 20% 12% 10% 28% 2% 13% Fomento Economico Siam Commercial Bank Hon Hai Precision In China Construction B Ping An Insurance Gr Sk Hynix Inc Gazprom Pjsc Housing Development Tenaga Nasional Bhd Sasol Ltd Vale Sa Me 7% 2% 6% 12% 16% 9% 18% 10% 4% 13% 5%

Kasikornbank Pcl-For Formosa Plastics Cor China Mobile Ltd Ind & Comm Bk Of Chi Naver Corp Sberbank Of Russia P Infosys Ltd Malayan Banking Bhd Standard Bank Group Walmart De Mexico Sa Banco Bradesco Sa-Pr

8% 9% 3% 5% 12% 15% 11% 9% 10% 10% 14%

Advanced Info Servic Formosa Plastics Cor Bank Of China Ltd-H Baidu Inc - Spon Adr Hyundai Motor Co Mmc Norilsk Nickel P Tata Consultancy Svc Cimb Group Holdings Firstrand Ltd Grupo Financiero Ban Petrobras - Petroleo

17% 9% 4% 12% 2% 27% 22% 1% 20% 11% 1%

Cp All Pcl-Nvdr Chunghwa Telecom Co Cnooc Ltd Jd.Com Inc-Adr Shinhan Financial Gr Tatneft Pjsc Hindustan Unilever L Petronas Chemicals G Mtn Group Ltd Grupo Mexico Sab De Ambev Sa

22% 9% 5% 11% 2% 26% 24% 7% 2% 9% 14%

Ptt Explor & Prod Pc Cathay Financial Hol Netease Inc-Adr China Merchants Bank Posco Novatek Pjsc-Spons G Axis Bank Ltd Hong Leong Bank Berh Sanlam Ltd Cemex Sab-Cpo B3 Sa-Brasil Bolsa B

2% 2% 25% 12% -7% 14% 15% 12% 18% -4% 18%

Kasikornbank Pcl-Nvd Nan Ya Plastics Corp China Life Insurance Yum China Holdings I Hyundai Mobis Co Ltd Magnit Pjsc-Spon Gd Itc Ltd Petronas Gas Bhd Absa Group Ltd Grupo Televisa Sab-S Banco Do Brasil S.A.

8% 7% -4% 23% 5% -1% 13% 9% 8% -2% 13%

Siam Cement Pub Co-F Formosa Chemicals & New Oriental Educati China Petroleum & Ch Kb Financial Group I Mobile Telesystems-S Icici Bank Ltd Maxis Bhd Nedbank Group Ltd Alfa S.A.B.-A Itausa-Investimentos

9% 8% 21% 4% 0% 1% 14% 5% 11% 9% 14%

Source: Bloomberg, Robeco. Largest stocks per MSCI Emerging Markets sector as of 31/12/2014, so halfway the decade. Total local return. Stocks with less than 10year history are measured from their IPO price.

13 | Article - For professional investors - February 2020

Appendix II: Factor construction

Following Fama-French, the US cross section of stocks is split in large and small caps. Subsequently, the small and large segments are grouped in terciles based on volatility, B/M, 12-1 price return, and dividend. The factor style portfolios are defined as the average of the big and small factor portfolios. Small caps are defined as the value-weighted average of all below-median NYSE stocks. The blended market is, like the styles, the average of small and large cap market segments. Since sorting stocks based on their past 1-year returns involves a lot of turnover, the momentum portfolio is defined based on the 2 tercile portfolios with the highest momentum, thus excluding the tercile with the weakest momentum. This reduces turnover significantly, and brings the academic factor definition closer to the industry definition which also has turnover constraints to limit implementation costs. Analysis period is January 1930 to October 2019.

14 | Article - For professional investors - February 2020

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