Investment sentiment turned bullish in the final quarter of 2023, marking a relatively abrupt and broad-based turnaround across global stock markets.

Rising equity tides washed ashore in regions ranging from Europe to emerging Asia. The most notable jump took place, however, in the U.S. where domestic small-cap value led the way. As captured by key IFA indexes, small caps also topped the fourth quarter's results in foreign developed and emerging markets. 

This might've come as a surprise to investors who were trying to trade stocks between quarters. It shouldn't to our long-time clients, though. IFA's wealth advisors stress that knowledge and education are the best ways to resist any temptation to speculate in markets, especially during times of heightened volatility. 

For those who felt an urge to engage in market timing tactics during the fourth quarter, we might suggest a review of the latest edition of Mark Hebner's book, "Index Funds: The 12-Step Recovery Program for Active Investors." 

In the 10th edition, which came out in 2023 and marked its 20th year in print, IFA's Founder and CEO highlighted a significant research discovery uncovered by leading academics: Higher expected returns are directly tied to a portfolio's exposure to a higher level of risk. As Hebner explained in Step 8, "economists have long sought to identify" the characteristics — or "factors" — of investment risk. 

Research by Nobel laureate William Sharpe and others in the early 1960s led to development of a coherent framework to figure out how much the risk of an investment affects its expected return. It was named the Capital Asset Pricing Model (CAPM). As Hebner put it early in his book (Step 2):

"This model explains approximately 70 percent of all stock portfolio returns. CAPM enabled investors to quantify expected returns based on how investments fluctuate relative to the market as a whole. It concluded that investments that fluctuate more than the market as a whole carry more risk than the market and, therefore, should also carry higher expected returns."

Still, Sharpe found that "some investments carry increased risk without providing the trade-off of higher expected returns," Hebner wrote. To help refine CAPM, market researchers at the time divided risk into two categories: systematic and unsystematic. 

In 1992, Nobel laureate Eugene Fama and his research partner Kenneth French expanded the financial sciences even further by introducing the so-called Fama/French Three-Factor Model. It identified three risk factors that can be used to explain as much as 96% of the returns of diversified stock portfolios — market, size and value. "Their data showed that small and value companies carried higher risk and that risk was rewarded," Hebner summarized in his "Index Funds" book. For investors trying to avoid any emotional pull to time markets, he added: 

"These small and value excess returns were shown to carry long-term persistence but were not consistent in short periods of time. More than ninety-four years of risk and return data confirm their results."

To help put into better perspective how these scholarly findings impacted a globally diversified portfolio of index funds, we recommend investors watch the following video. In it, Hebner marks IFA's 25th anniversary by applying a distinctly strategic view in analyzing results from the fourth quarter.

Domestic Equities 

Domestic stocks gained significant ground in Q4 2023 as all six of IFA's domestic equity indexes posted positive returns. Not all types of assets, however, rose at the same pace. Indexes focused on small-cap stocks performed better than those focused on shares of larger companies. Small growth, which historically has been a long-term laggard, produced double digit gains. Still, small value (as covered by its sister IFA index) outperformed in the quarter by more than two percentage points. By contrast, IFA's blended index of large-cap stocks returned a healthy 11%-plus. But that was 3.5 percentage points less than small-cap value. Also worth noting: For the year, all major IFA U.S. stock indexes wound up producing double-digit returns.

International Equities

Although U.S. stocks outperformed, the blended IFA index tracking international developed equity markets still produced solid positive returns in Q4. The quarter's leader among major indexes was the IFA International Small Company Index, which blends value and growth stock styles. The IFA small-cap focused value index tracking international equities came in next with a gain of nearly 9%. At the same time, the large-cap dominated IFA International Value Index rose by more than 6%. Notice, too, that each of these IFA international developed indexes ended the year with double-digit returns.

Emerging Markets Equities

Stocks issued by companies based in developing countries showed positive results in Q4. In particular, IFA's blended index of small-cap companies outperformed its sister emerging markets benchmarks. Meanwhile, all of these IFA emerging markets indexes finished 2023 with double-digit gains.

Real Estate Equities

In a quarter that saw real estate markets generate strong gains around the world, U.S. REITs outperformed by better-than a full percentage point, according to a survey of major global indexes by Dimensional Fund Advisors. That was significant since domestic REITs (real estate investment trusts) represented an estimated 68% of total global assets invested in real estate markets at the end of 2023. 

Fixed-Income

In the fourth quarter of 2023, the 30-year U.S. Treasury rate decreased by 0.78 of a percenate point to yield 4.03%. At the same time, the 10-year U.S. Treasury rate fell by 0.81 of a percentage point to 3.88%. Also, the five-year U.S. Treasury rate dropped by 0.88% to 3.84%. If interest rates have increased, the price of existing bonds can generally be expected to decrease, and vice versa. 

For Q4, IFA's fixed-income benchmarks produced returns topping 1%, which can be considered as robust in rather staid global bond markets. Three of the indexes generated 1.34% or better results. The IFA Short Term Government Index finished slightly lower with a return of 1.27%. All four IFA bond indexes managed to build on the previous quarter's positive returns. For the year, each posted total returns of approximately 5%.

IFA Index Portfolios

The fourth quarter illustrated an ongoing theme we've seen over longer periods — namely the value of investing in a diversified portfolio of stocks and bonds. As a result, we like to encourage novices as well as experienced investors to engage in an ongoing conversation with an IFA wealth advisor regarding each person's risk capacity. Besides offering an online Risk Capacity Survey, we provide to each client a complimentary and holistic financial plan. 

Below is an overview of how several IFA Index Portfolios performed in Q4 as well as over three-quarters of 2023. All of these returns are shown net of the maximum annual 0.90% advisory fee through Dec. 31, 2023.

Each quarter, we monitor our recommended funds for clients. As part of that process, we've developed a rating system. For a summary of those results, please feel free to check IFA's latest Performance Monitoring Report (PMR). 

The wealth of IFA's educational materials are available for Apple iOS and Android devices via the IFA App. This free App is available to download from both the Apple App Store and the Google Play Store for Android.

Performance results for actual clients that invested in accordance with the IFA Index Portfolio Models will vary from the backtested performance due to the use of funds for implementation that differ from those in the index data, market conditions, investments cash flows, mutual fund allocations, changing index allocations over time, frequency and precision of rebalancing, not following IFA's advice, retention of previously held securities, tax loss harvesting and glide path strategies, cash balances, lower advisory fees, varying custodian fees, and/or the timing of fee deductions.

This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. Performance may contain both live and back-tested data. Data is provided for illustrative purposes only, it does not represent actual performance of any client portfolio or account and it should not be interpreted as an indication of such performance. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you. For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.