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2020 will likely turn out to be one of the most difficult markets to navigate for investors, financial advisors, and portfolio managers. It’s in difficult times that strategies get battle tested. Most everyone looks smart when the trend is with you and the economy is strong and accelerating. It’s in difficult times that investors should asses their current portfolios to see which funds, mandates, and styles really add value for the fee paid. In this blog I want to shed some light on a topic I have been talking about for over two decades: The perils of too much exposure to style stubborn strategies.
The Golf Analogy
I’ve used this analogy before, and I feel that it deserves some additional focus given today’s market. If you are playing golf and your goal is to play the best game possible, with the lowest score, and to have the best experience on the course, is your best chance to accomplish these goals driven by having more flexibility or less? I think most people would say having more flexibility to adapt to the current situation makes more sense. If I said you had to use every club in your bag, regardless if it was the right club for the course, do you think you would turn in your best game? Probably not. From my perspective, the best chance at having a great golf day is to assess the course and decide which clubs give you the best chance of turning in a great score based on all the other variables.
Linking Golf to Investment Styles
Most investment strategies available to Advisors and individuals manage to a particular style. Growth or value, large cap or small cap, domestic or international to name a few. Consider each style to be one of the golf clubs in your bag. The conventional wisdom in our industry tells us we should own all the styles of investing which is akin to being told we have to use every golf club in our bag regardless of what the conditions are. Being style-focused & forcing yourself to own everything all the time is often the reason for chronic underperformance. Why? It’s not because the investment teams of underperformers have gotten stupid, it’s likely that they are selling chocolate cookies when the market is rewarding vanilla. One can choose to sell chocolate but you must understand you will sell less cookies.
Let’s look at the period beginning at the bottom of 2009 until today and analyze large cap growth with large cap value. From March 9, 2009 until about February 2015, there wasn’t much edge to tilting a portfolio towards value or growth, they both performed well in a rising market and economy. But when the economy started to struggle, growth stocks continued their winning ways and value stocks started lagging badly. Intuitively that makes sense, if the economy is growth challenged, companies that exhibit more stable growth or high growth will tend to get the benefit of money flows while companies that are growth challenged become less interesting for investment. An allocator that is forced to buy value stocks, like the chocolate cookie salesman example, will suffer as demand is focused elsewhere. Doing the research and allowing yourself or your investment managers to have more flexibility can add a significant amount of total return to your portfolio. Here’s the growth versus value chart using the ETF’s, IWD and IWF.
The Compounding Effect Across Your Portfolio can be Dramatic.
Making the decision to be equal weight different style factors versus being willing to tilt a portfolio towards those that are outperforming can have significant portfolio implications. Why? Because of the compounding effect of these decisions. Every asset class has a mind of its own so not paying attention to the interplay of different asset classes and styles can often lead to having a portfolio woefully wrong-suited for a particular environment. I’ll use a few more examples that are still true today. Domestic versus international as well as showing sector performance. Simply by either doing the research on your own or outsourcing those decisions to managers, more enhanced returns can be delivered. In the domestic versus international chart below, the blue line is the S&P 500, a large cap, domestic index of 500 companies. The orange line is the EAFE Index which is developed countries without the United States. The red line is the Emerging Markets economies via the VWO ETF. As you can see, since 2009, there has been radical outperformance by U.S. stocks versus their international counterparts. One day these things will change but for investors, we now know an active decision to overweight growth versus value and domestic versus international was a very smart and money-making decision.
Next up, let’s look at how a few sector decisions could have added or detracted from performance.
The blue line is the Consumer Discretionary sector via XLY. The Red line is the Tech sector via XLK. The orange line is the financials via XLF, and the lowly green line is the energy sector via XLE. Again, one day many of these trends will reverse but if you don’t have someone monitoring these trends and pivots, you’ll never be able to benefit from them. Since 2009, it’s been a very smart decision to own strategies that had a meaningful weighting in the consumer and technology stocks and avoiding financials and energy added lots of value and reduced possible portfolio angst.
Lastly, let’s look deeper into style factors by comparing high beta (more volatile than the market) with lower beta stocks as well as high dividend stocks and dividend growth stocks. Clearly your portfolio would have benefitted if you owned more of the blue and green styles (lower beta and higher dividend growth) versus high dividends and higher beta stocks.
The chart below shows the last five years.
Bottom Line:
In summary, here are some takeaway points for investors:
- Like golf, portfolio construction and results are enhanced when you have lots of flexibility.
- Our industry tells you that owning every asset class all the time is the best approach.
- This approach mostly leads to a watering down of total portfolio returns.
- Implementing strategies that have lots of flexibility to adapt offers a portfolio edge.
- Significant excess return over the last 10 years could have been achieved simply by tilting a portfolio to domestic, high growth companies as well as having an allocation to lower beta industries and those companies with high dividend growth over absolute high yielding dividends. Our team has certainly benefitted from doing this analysis.
- Outsourcing research to managers that utilize it in their investments can save time and add returns.
Disclosure:
This information was produced by and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed. Any sectors or allocations referenced may or may not be represented in portfolios managed by the author, and do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results.
