Beating the S&P 500 with the Best of the S&P 500
The debate continues about whether it is possible to outperform the S&P 500 over time. At Investoristics, we think the answer is yes especially if your approach is based on common sense and is grounded in investment fundamentals. In a recent article, we discussed our view on the number of stocks most investors need for adequate diversification and that number is 10. In that same article, we also provided historical return information on our model portfolio, The Investoristics 10, which significantly outperforms the S&P 500 with lower risk over time. However, there will always be investors who cannot buy stocks that are not members of the S&P 500, or they simply prefer the highly liquid stocks of the S&P 500.
So, who are these investors that typically prefer the comfort of investing in the S&P 500? Well, some retail investors, Family Offices, Endowments, RIA firms that pick their own stocks for clients, and some highly focused mutual funds, as well as some pension funds looking for skilled managers who can add value beyond investing in index funds.
For these situations, we would use the same database that we use for selecting stocks for our flagship portfolio, The Investoristics 10, but exclude any stocks that are not members of the S&P 500 and then apply our selection criteria. The performance of this 10-stock S&P 500 model portfolio, not surprisingly, outperforms the S&P 500 handily, delivering an average rate of return of 18.1% vs a little over 10% for the S&P 500 over the 18-year period ending on December 31, 2021. We expect this outperformance differential to persist over any long-term period.
It is important to note that there are always limitations when using back-tests to provide historical performance information on model portfolios. When developing our selection criteria, we try our best to build models based on what we do in real time as we manage our flagship portfolio. However, there are things that you simply cannot model easily. The drawback to blindly using screens or similar quantitative approaches is that a purely quantitative approach cannot account for the qualitative things that also add value to the process. For example, a purely quantitative approach does not address risk management, the optimal rebalance period, and often recommends stocks that are a bit too pricey which reduces your long-term performance. Despite these limitations, the 10-stock S&P 500 model portfolio still delivers superior results vs the S&P 500 over time.
What happens if these qualitative factors are introduced to the process? Based on our experience, we find that over time, an additional 2-3 percent can be achieved on top of what the back-tests show. Not only do the qualitative factors add return but they further reduce the risk profile of the 10-stock portfolio relative to the S&P 500.
If you are investing less than 500 million dollars in equities, then you probably are not concerned about the liquidity necessary to implement this S&P 500 only approach. Having a superior equity strategy that provides significantly higher returns than the S&P 500 with lower risk is what most retail or other investors should be seeking. Imagine being able to spice up the performance of your basic asset allocation strategies used by most investment professionals. Feel free to reach out to us for more information on our process or the performance details of The Investoristics 10.
