It’s been interesting to note how the smart money crowd has gotten it so wrong lately.
From the erstwhile Bond King, Bill Gross, fired from his mutual fund company, PIMCO, to Michael Aronstein, the “alternative” investment wizard at MaintStay Marketfield, which suffered massive shareholder redemptions last year, the smartest guys in the room have been tripped up by the fickleness of global economics.
If these undoubtedly brilliant people with access to copious data and talented researchers get it so wrong, how are the rest of us supposed to decide how to invest?
Some, like these managers, try to color their bets based on their view of economics, so-called “top-down” investors. Others try to pick investments that they believe are trading below their intrinsic value – “bottom-up” investors.
The problem with both of these groups is that they can be right for a number of years, bringing in loads of new customers, and then circumstances change too rapidly for them to adjust. Success begets size which kills sure-footedness.
And who can blame them for getting things wrong? When it comes to the global economy, there are too many moving parts for anyone to consistently predict where markets are heading.
Who could have foretold that last year Saudi Arabia would keep the taps open amid a global supply glut and halve the price of oil?
Who can (or would want to) get inside Vladimir Putin’s head and know his true intentions in Ukraine, assuming he’s even clear on that himself?
Who could forecast months ahead of time that a leftist party would take power in Greece, how the party would act once in power and the reaction of other European countries?
Who knows what effect China’s alternating attempts to cool and stimulate its economy will ultimately have on other emerging markets and the global economy?
How many people really expected long-term Treasury bonds to be the best investment of 2014?
The media is constantly in search of the latest prediction for what will be the next hot thing. I was quoted on the financial news website Bankrate.com last year saying international investments were a good bet for 2015. So far so good, but I wouldn’t bet the granja.
In 2014, only 19.9 percent of active managers beat their benchmarks, according Barron’s, citing data from Morningstar. The best strategy was – as usual – to buy index funds and beat most managers by holding down investment expenses.
Index funds, particularly the large-cap ones, shined brightly last year in part because many investments moved in sync, making it hard for active managers to stand out. Even so, it’s amusing to hear – for the umpteenth time – that this time it’s a “stock-pickers market.” That hoary expression is usually expressed by, well, stock-pickers and those who profit from promoting them.
Mathematically, the average active manager will underperform the market as a whole. The return of the market will exceed the average active manager’s results because it is not dragged down by investment expenses. While it is true that in down markets, actively managed funds can outperform index funds because of the cash that active funds hold, uninvested money acts as a drag in the more numerous rising markets; moreover, an individual investor can hold savings as a reserve to create downside protection without paying for it.
Another argument for actively managed funds is that, compared with market-weighted indexes, they may be less prone to bubbles: In a market-weighted index, highly valued stocks might create an undue influence on the fund’s composition. Many index funds are market-cap weighted, so if a stock is more expensive (think dot.coms in 2000, financial companies in 2007) , there is more of it in the index. I give this argument a bit more credence because bubbles are not necessarily easy to identify ahead of time, and even if they are, it’s difficult to time when to get out. Yet I would still generally prefer the certainty of lower fees to the possibility of a larger correction.
Barron’s magazine opined that 2015 could represent the “Return of the Stockpickers.” One of the arguments is that small cap stocks do better when rates go up: “… rising rates go hand-in-hand with outperformance of smaller stocks, which active managers tend to favor.”
This is really an argument for adjusting, or perhaps tweaking, which asset classes one invests in. In a sense, this would be active management, but it is not pure security selection. Many mutual fund managers actually can’t do this to a significant extent because they are required by their prospectuses to stick with certain investment characteristics.
But does it make sense for individual investors to tweak or “tilt” a portfolio for short-term, strategic reasons? For example, choosing investments that hedge against the rising dollar paid off for some investors last year. Absent hedging, when the dollar increases in value relative to the currencies that the assets are invested in, the performance in dollars can significantly underperform the results in local currencies. The strong dollar trend persisted all year and continued into this year.
Such moves can pay off for a while and sometimes a good while, but when will the time be to reverse course and go “long” the yen and the euro and “short” the dollar? By time anyone has figured that out, it may be too late to do anything about it.
Even so, I explained to a client recently that one advantage of having someone manage your assets is that on occasion the advisor can make short-term adjustments to benefit from market trends such as this. Then I said, “but you know, if you are going to be a long-term investor and are willing to rides the ups and down, you will probably do just as well, if not better, by picking a stable, long-term allocation and sticking with it.”
A fast learner, her response was: “exactly.”
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