2016 Wrap-Up Observations

December 30, 2016

Last newsletter I was getting all warm and fuzzy with you. No more. This week we are talking hard numbers in our 2016 wrap-up.

In indexing, our "competitors" are active managers and stock pickers. How did we do in 2016? Sadly for them, once again it was a blowout. Just 18% of active managers beat the Russell 1000 index through early December according to Bank of America. That's their worst performance since 2003. Frankly I think 18% is too generous for various arcane reasons, but we'll stick with it for now. If you want to do some fun math, multiply .18 x .18 x .18 and you can get a sense of the probability of an active manager beating for three consecutive years (hint: it's below 1%).

For 22 consecutive months Americans have pulled money from active funds. People are taking notice. But active funds still dominate the financial landscape in terms of overall money invested.

Let's look at what asset classes did well, from a price perspective, in 2016. There wasn't a lot of financial news around emerging markets this year, but for much of the year, until the U.S. election, they were the leading asset class geography! This changed in November and U.S. small capitalization stocks ran away with the show, notching dividend-included gains of almost 20%. Emerging markets did almost match the S&P 500. Developed international markets dragged again, barely locking in positive returns after dividends. And bonds, which led mid-year, turned in the worst performance, hovering near zero after dividends.

Keep in mind that this type of analysis is somewhat arbitrary as the start date of January 1 is arbitrary. Change the start date by even 30 days and the analysis can look very different. I am including this because 1. you have to use a start and end date, and the calendar year is a traditional choice and 2. at New Year's parties I want you primed to go if someone throws a financial curveball into the discussion. Ask them about their exposure to small caps.

Note that I say "price perspective" above. Remember, as investors we are business owners, and what you care about when owning a business is not what someone else thinks your business is worth (its price), but how much cash it generates for you as an owner. Cash generation is measured using retained earnings and dividends.

On the dividend front the fourth quarter was exceptional. Index fund dividend payouts jumped 55% in one year in the real estate index. They rose 19% in the S&P 500 and 20% in U.S. small caps. In emerging markets they rose 7% and in developed international markets they went up 36%. These are quarterly numbers, not yearly numbers.

To put this in perspective, on average dividends rise 4% - 5% year over year.

Perhaps best of all, because of the One Day In July model, *all* of the dividend cash above flowed into client accounts.

Someday this revolution won't be as quiet as it is now, but today, I'm happy to report, our snowball is rolling downhill. With that, folks, we're signing off for 2016.

Dan Cunningham