Standard & Poor’s 500 moved down 5.8% in less than five weeks. The index has since recovered somewhat, and now sits 3.8% off its record high of 1669—up 12.6% for the year. The benchmark yield on 10 year Treasuries jumped to 2.61% from 1.63% in just two months before settling near 2.5%. Commodities have been experiencing declines. See http://www.bloomberg.com/markets/ for full coverage.
Uncertain Times
It is always fascinating to hear the pundits and publicity seekers that appear in financial media television and print speak of the uncertain and perilous times that we now live in. One can only wonder when the times were more clear and certain. A reasonable estimate would be never. The day of clarity has never been and will not be showing up any time soon. Forget about it.
The time you are in and decisions that you face are always going to be challenging. Only in hindsight can investors look back and see the path that was best.
The perpetual conundrum of striving to figure out what is the right thing to do causes many inventions that might be better left unimagined. On June 27, 2013 the Wall Street Journal had a piece titled “Fashionable Risk Parity Funds Hit Hard”. http://online.wsj.com/article/SB10001424127887323689204578572050047323638.html?KEYWORDS=risk+parity+funds
This “Risk Parity” concept is another example of the pursuit of investments that do well in all environments. According to the WSJ article, “The basic idea of the strategy is that by equally distributing risks among stocks, bonds and commodities, the portfolio can weather huge price swings without sacrificing returns.” Sounds a bit like the Holy Grail. Needless to say, it is unlikely that this will be the answer to all of our investing problems.
Risk Parity has been embraced by the Hedge Fund industry. These asset managers are made up of some of the most clever people on earth, many of them legends to the investment world. This is an investment world based on the concept of “two and twenty”. This means that you pay 2% in management fees as well as 20% of profits. Only “accredited investors” ($1m net worth or $200,000 in annual income) qualify. Hedge Fund managers are extremely motivated to produce profits in which they share 20%. Invented in the early 1950s in the United States, they have become a significant force in many investment markets globally. Famed investor Mario Gabelli once was quoted as saying, “I suspect most folks would characterize it (Hedge Fund) as a highly speculative vehicle for unwitting fat cats and careless financial institutions to lose their shirts”.
I am skeptical of Hedge Funds. It is a realm of investing that is murky with sometimes minimal information available on what the actual portfolios hold. The complexity in hedge fund offerings is often quite high. The industry concepts come and go, with some great performers and also many blow-ups along the way.
The Risk Parity seems to be striving for the impossible. Doing well in all environments is unlikely to happen, in my humble opinion, regardless of how clever the manager is. It is important here to emphasize that there have been many ideas over the years that focus on minimizing loss.
Loss avoidance is a dynamic that leads many investors to seek solutions that can cost more than market fluctuation and volatility ever will. Investors need to always accept that great investment strategies historically have ups and downs. Moderate diversified portfolios will be down more than we would like, but rewards for patience have been significant historically. As holding periods increase to five and ten years, the odds of having solid gains increase dramatically.
Currently there are a lot of concepts that are being articulated often by insurance companies that I find highly questionable. The following items are things that I believe are often said to prospective investors to entice them into financial products with very low potential for growth. Watch out if you are told any of the following…
While choosing investments with good rates of return is important, it is our first priority to avoid loss as much as possible. While the idea of guarantees is wonderful, what the cost is in lost growth is often never discussed.
The first way to get a good rate of return is to not go backward. Fluctuation is a big part of being a long term investor. Investments that never fluctuate often have little potential to grow beyond the rate of inflation.
Consider the risk/return trade-off of any investment before investing. Develop well-defined sell strategies to protect gains in the event of a market downturn. Defined sell strategies are for traders, long term investors need to avoid the notion that you can buy low and sell high.
Look for investments that have performed well in both strong markets as well as volatile markets such as 2000 to 2002, 2008 and 2011. Judging investments by down years can lead to a negative conclusion. Look at longer periods like five and ten years to see what you can reasonably expect with the understanding that it will take time to achieve reasonable returns.
Try to avoid loss whenever possible. Using loss as a primary criterion can lead to missed opportunity and much lower outcomes for your investments. Investing will never be easy, but the good years have balanced out the bad years over time to produce solid results in moderate portfolios.
I am often presented with products by insurance companies that look to avoid losses. It would be incredibly exciting to find strategies to protect gains so that I could deliver portfolios to clients that would eliminate the down years. As I track these types of investments (usually fixed index and other types of annuities) I find that they deliver very small returns with lots of restrictions on the withdrawal of money. The returns of the safe investments are often so small compared to moderate diversified investment portfolios that the cost of the low volatility can defeat the purpose.
The notion of avoiding volatile years, such as 2008 is an incredible statement. The years 2007 to 2009 were one of the worst periods for investors in many decades. I would say among the worst in post 1929 investment history. It is not a timeframe that should be used as a benchmark in our thinking and strategy. It is always possible that we will face more financial crises, and it could even be soon, however, as we have seen markets seem to recover and progress along long-term historical patterns.
It does seem that 2007-2009 is a period that continues to reverberate in the mass psychology of markets all over the world. Fear of a return of the virus that infected almost every type of market based investment globally is causing markets to trade in a very nervous way. This trading is not something that is going away, and as long term investors, we must strive to ignore the swings that continue daily. We also see more and more technology embracing rapid fire trading that causes that market to react very quickly to news, speeches and all sorts of events that drive short term movements.
All this movement drives the search for new answers. I find that “new” often leads to disappointment in contrast to long-term patient investing that has historically produced strong results. Could it even be cool to own stocks again? As the market goes into the fifth year of the post crisis recovery, those that made changes to portfolios in the 07-09 crisis are now faced with new decisions to make. One can only imagine the angst of selling out of the market and then proceeding to observe new all time highs for the Dow and S&P 500.
History is the guide. The past results for patient investors are very hip indeed. Stay calm and long term minded. It will not be easy, but the rewards are coming.
*The Standard and Poor’s 500 (S&P 500) is a market capitalization weighted index of 500 widely held domestic stocks often used as a proxy for the US stock market.
The Dow Jones Industrial Average (DJIA) is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities.