I received a call from a relatively new client (December 2008) over the weekend wanting to know why she wasn’t up as much as an index fund in 2009 and did I think she would be better eschewing active management and putting all her money in an S&P 500 index fund.
Now I invest in baskets of stocks via closed-end funds and ETFs, but it just doesn't make sense to me to buy an ETF or open-ended mutual fund in order to exactly match the "market." The index ETFs I buy are for a particular sector and with a finite time frame, whether 6 months or 6 years, in mind. But her idea of buying and holding an instrument that will never under-perform (except by the amount of the management fees) and can never outperform the market makes little sense to me.
She had a right to ask the question. After all, I expected a correction in 2009 that never came and invested more conservatively. As a result, she was up just 12% while the S&P 500 was up a whopping 23.5%. There are times, and I saw 2009 as one of them, when the risks are as great or greater as the potential rewards, and at those times we’d rather have the discipline to leave something on the table for others than try to stop a freight train by standing in front of it.
But one swallow does not a summer make. In fact, our documented results show that our Growth & Value Portfolio, in existence for the past 11 years, was up 236% including our under-performing 2009. An S&P index fund, on the other hand, was down the 9.3% the benchmark returned, less any (small) management fees. A minus 9%+ for 11 years invested does not inspire wonder. That’s a pretty convincing case, to me, that experience and a willingness to rebalance, allocate assets, and seek exceptional stocks, brings value to the investing process!
Worse, had my client invested in an index fund at the beginning of 2008 instead of at the end, she would have been down a fibrillating 38.5% that year, and it’s doubtful she would have enjoyed the resurgence in 2009. Why? How many people can watch $300,000 become $184,500 and blithely say, “I’m not worried. Since I believe Burton Malkiel and John Bogle that no individual can consistently beat the market, I know I’m doing the best I can.” Not many.
So the “theoretical” return to the mean or, dare we think it, the previous high, is seldom matched by individuals in The Real World because in The Real World people have emotions. These aren’t just numbers on a screen to us, like they were to the acadamic Dr. Malkiel, they are our future we see slipping away. So we – quite rationally – rush to stem the flow of blood. When we sell as the market looks to slide even more, against Mr. Malkeil’s and Mr. Bogle’s supposedly “sage” advice, we have, inadvertently, become market timers. That’s a no-no in their make-believe world.
My client sent me a link to a website titled “Distinguishing Between True Investment Skill and Luck", which asked the question, “Even if an investor has obtained superior results over an extended period, is this sufficient proof that these investment results were actually due to skill?” They answered, “No, these investment results could still be due to chance.”
I shook my head at that one. Even if it were true, would you rather have 10 years and be up even if the recommendations were ‘just luck’ (which I doubt; it’s tough enough to string two good months back to back in this business, let alone 10 or 15 years, as some have!) or would you rather be down, but know that you were in line with everything the market provided? Stated differently: is it more important to you to be right or more important to you to be rich?
This is not at all a flippant question and, if you are to be a successful investor, you need to know the answer. I know plenty of people who rail that there is no reason the market should be higher than 6500 right now and they invest accordingly. It’s important for them to be right, so they act upon their deeply-held conviction that they are right and the markets (that is, all the rest of us) are wrong. Conversely, there are those who will not admit to the possibility that the market could decline and they are rabid in their denunciation of those who allow for that possibility.
Both of those investors would be happier, and more successful, with an index fund in a blind trust that they never see until they retire, while they spew forth their invective and certitude to all and sundry. Me, I haven’t got a clue what the market will do tomorrow. Day-to-day, it’s a crapshoot. I have a better idea when I look out a month or more based on the overbought or oversold condition of the market itself. And if there are no earth-shaking or market-shattering events in the meantime, I can look out 6 months to a year and make an educated guess, but that is subject to rapid revision if some religious zealot decides to murder 3000 innocent civilians to gain entry into his idea of heaven, or if The Evil Empire falls and ushers in 10 years of peace dividend, etc.
I gave my client the only honest answer I could: if she didn’t mind gyrating with the market and she believes the future is rosy, she might do every bit as well in an index fund as she would with our, or any other, active management. If, however, she agreed with me that there is “Danger, Will Robinson!” ahead and these will not be easy times to make money just by grabbing the coattails of America’s biggest 500 companies, she might want to stay put.
I may be the wrong person to ask. Not because I don’t want to lose a client – if that’s what’s better for her and she’ll sleep better at night knowing she can never do worse than the market in any one year (or any better) that’s a good move for her.
But I wouldn’t know; I’ve never owned an index fund. I cannot imagine abdicating my responsibility to myself to follow the three steps we follow when making investment decisions:
1) re-balancing as appropriate to do our best to be more “in the market” when it is rising and less in when it is declining;
(2) determining the best asset classes and sectors within those asset classes to maximize potential gains; and
(3) selecting those companies’ stocks we believe are most undervalued and offer the highest appreciation potential within our favored asset classes and sectors.
Did we have a less-than-the-market performance in 2009? Yep. Did we hew to a discipline that has allowed us to earn 236% while the market declined 9% from 1999 through 2009? Yep. Could this be explained by pure luck? I suppose so, but then I’d have to tell Mssrs. Malkiel and Bogle they must be among the unluckiest fellows to grace the current millennium!
So what does my cloudy crystal ball tell me right now? Absolutely nothing. But my experience of 40 years, and my research, and my analysis of current events tells me we could be both volatile and range-bound for the next half-year or so. That’s not a contradiction: we could be range-bound between some numbers on the Dow; say, 8000-11,000, or 8456 to 10,712 if you are a technician who picks such things with such exactitude. But we could see some violent up-moves and downdrafts within that range.
So I am positioning for rock-solid income; for the probability that rates and yields will rise and therefore existing bonds, whether Treasury, corporate or municipal, will fall; for volatility; for the unexpected crisis or two that will send investors fleeing to gold and other safe havens; and for the likelihood that there will be some terrific bargains down the road. Here are some thoughts for your further research.
Against the probability that yields will rise and bonds will fall we’ve bought the iShares TIPS Bond ETF (NYSEARCA:TIP), the ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) and the Direxion Daily 30 YR Treasury Bear 3X (NYSEARCA:TMV) – recognizing the inherent volatility of leveraged ETFs in these latter two.
The way we’ve chosen to play the possibility of extreme volatility is via the iPath S&P 500 VIX ETF (NYSEARCA:VXX). Since most people will wait to sell until all others are selling, we’re betting, via VXX, that volatility will rise.
In the precious metals / crisis protection arena, I provide for your further research Goldcorp (NYSE:GG), Kinross (NYSE:KGC), Agnico Mines (NYSE:AEM), and Yamana Gold (NYSE:AUY), as well as the royalty firms Franco-Nevada (FNNVF.PK), Royal Gold (NASDAQ:RGLD) and Silver Wheaton (SLW.) (For more on what makes these last three unique, see here.)
Finally, for those bargains I expect down the road, we have a solid cash position. This will harm us if the market roars ahead as it did in 2009 and we are on the sidelines with up to half our funds – but it will keep us in good stead in any other scenario.
Personally, I’ll take my chances in the arena rather than be a spectator via index funds. Your mileage may vary...
Author's Disclosure: We and / or clients for whom these investments are appropriate, are long NRP, PVR, MMP, BWP, EEP, KMR, BPL, PGH, ERF, CM, ATLIF.PK, CM, NZT, FTE, TBT, TMV, TIP, VXX, GG, KGC, FNNVF.PK, RGLD and SLW – and a very large cash cushion.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but did not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.