Investing is a process better guided by evidence than emotion.

An evidence-based, systematic approach focuses on long-term data to build portfolios designed to deliver superior returns over the long term. Research, supported by decades of evidence, has identified three primary biases that can enhance performance: smaller companies, emerging markets, and value stocks.

Smaller companies often go under the radar compared to their larger peers. Historical data has consistently shown they outperform large companies over the longer term. Their agility, entrepreneurism, and greater growth potential typically generate better returns.

True, smaller companies are more volatile, and their performance can falter during periods of market stress or recession. However, in the current environment, where economic growth is rebounding, albeit unevenly, smaller companies are recovering. They are less exposed to macroeconomic or geopolitical risks and often have leaner, low-cost operations that make them attractive.

Meanwhile, emerging markets represent many of the world’s fastest-growing economies, which are home to vibrant companies and growing middle classes. Over the long term, emerging market shares tend to provide higher returns than their developed-market peers, driven by faster growth and supportive demographics.

Of course, emerging markets come with their own risks such as regulatory uncertainty, political instability, and currency volatility. But for well diversified investors, these risks have in the past been compensated by higher returns. After a decade of underperformance, as inflation slows post Covid, many emerging market economies are showing resilience and growth making them particularly compelling.

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Buying “value” stocks, practiced by well-known investors such as Warren Buffett, involves buying stocks below their fundamental worth. These companies often operate in unloved sectors, perhaps where investors have overreacted to bad news, or they may face temporary challenges that they can recover from.

Over time, the market tends to "re-rate" such stocks, rewarding investors with superior returns. Today’s market of higher-interest rates and inflation have created such dislocations, especially in sectors such as energy industrials and financials.

While growth stocks have been in the ascendancy in recent years, rising borrowing costs have dampened their appeal. In contrast, value stocks, which are often overlooked in a bull market, may now outperform as their steady earnings and dividends become increasingly attractive. By maintaining discipline and avoiding emotional reactions to short-term market fads, investors can allow market inefficiencies to correct over time. Instead of chasing momentum or trying to time the market, an evidence-based approach relies on allowing undervalued stocks to realise their potential via the “re-rating” process.

A completely passive approach to investment is unlikely to result in optimal performance, even if it is low cost. For example, a market-cap-weighted index, such as the MSCI World, has an in-built bias toward the largest companies. Over time, this can lead to concentrated exposures in a small number of overvalued mega-cap stocks, leaving passive investors overly reliant on a narrow segment of the market, as may be the case today.

By tilting toward smaller, emerging market and value stocks, evidence-based investors can avoid some of this distortion. This tilting approach ensures portfolios are better diversified and aligned with long-term return drivers not current market fads.

The combination of smaller company, emerging-market, and value biases, coupled with a patient evidence-based approach, offers a solid framework for investors. While the future is unknown, sticking to evidence-based strategies allows investors to focus on capturing long-term returns whilst simultaneously avoiding the pitfalls of speculation and short-termism. In a world dominated by noise, evidence-based investing remains a rallying cry for clarity and discipline.

David Thomson is chief investment officer at VWM Wealth