Do you remember your first car? You’ve probably had a good time there – passing your driver’s license exam, going to prom, driving to your first job. Now that you’re older, you probably have another car – one more suited to your lifestyle and current needs. I bet your current car is much safer and more reliable than the first. A car is a motor vehicle that you use to reach your destination. Like a car, an investment portfolio is a vehicle you use to achieve your clients’ investment goals.
My first vehicle was a 1962 Land Rover. I bought it when I was a teenager for a few thousand dollars. It was a faded green safari vehicle with a spare tire on the hood, a crank start handle that extended through the front bumper to run the inline 4-cylinder engine even with a dead battery, and removable doors and roof for outdoor summer driving. The Rover looked like it was coming out of the Serengeti plains. With its sturdy leaf springs, it wasn’t the most comfortable vehicle, but I could usually rely on it to get me where I was going. It wasn’t really a “sport utility vehicle” – it was more of a utility vehicle. The Rover was not very fast; I could comfortably ride it around 55 MPH on the highway, it wasn’t comfortable either, but it was generally pretty reliable.
Later in life I drove a sports car. It was a 2-seater convertible with a 390 horsepower V8 engine. It had a Formula 1 style transmission, with steering wheel-mounted paddle shifters. This car was fun to drive and fast. The issues I had with the sports car, however, made me realize that it really wasn’t the right vehicle for me. Low profile tires tended to develop frequent sidewall failures – golf ball sized blisters came out of the tires whenever I drove over any type of pothole on the street. Replacing these tires was expensive. In addition, the sports car was rather useless in winter – with more than several inches of snow, it literally fell in the snow and required towing. Normal maintenance costs were several orders of magnitude higher due to expensive Italian parts. One day the automatic roof stopped working for some mysterious reason and returned to the store. While the car was comfortable and fast, it turned out to be an inconvenient vehicle to get me to my destinations consistently.
Your customers have goals they want – in many cases, need – to reach; often to plan their lifestyle during their retirement years. There is a wide variety of styles and investment strategies to choose from.
Some managers take the “utility vehicle” approach to investing. They aim to function as a market index and their portfolios may grow over time, but because these portfolios can exhibit market-like volatility and expensive drawdowns, clients may take longer than expected to meet their investment goals. ‘investment. This approach has sometimes been called “closet indexing”. It can be an uncomfortable race for investors with real investment goals.
Other managers take the “sports car” approach to investing. Their portfolios take higher risk and appear to do well in strong market environments, but in turbulent and falling markets they can lose even more value than the markets. Sometimes this is caused by hidden or unnecessary risk exposures in the portfolio, and it seems to be a common feature of an exclusive focus on growth-oriented stocks. Such capital losses are extremely difficult to recover, with or without active management.
The utility vehicle approach (closet indexing) and sports car investment style (high risk growth) can allow a portfolio of stocks to perform well in strong bull markets, like the one we are enjoying today. Today and 1999-2000. In the later stages of a bull market, we often find that growth-oriented stocks outperform stocks with reasonable valuations. In the third quarter of 2013, growth stocks achieved nearly double the return of value stocks. The problem is that they can both lead to unacceptable losses of capital in less benign times, such as the market correction in 2001-2002.
Is it possible that we are in the last innings of the current bull market? The chart below compares the current stock market as represented by the S&P 500 Index with the expansion and contraction of the stock market 13 years ago. The current market has been up for four and a half years since its last major correction in March 2009. The growth path of the current bull market is remarkably similar to the growth of the market during the “dot-com bubble” from 1996 to 2000. In the graph below, the solid line shows the current market through the end of the third quarter of 2013, and the dotted line shows the rise and fall of the dot-com bubble that began to implode in September 2000.
For example, $ 1.00 invested in the S&P 500 index at the bottom of the market in early March 2009 would have risen to $ 2.29 – more than double in value – at the end of September 2013. This is very similar to the growth of the S&P 500 Index thirteen years earlier during the dot com bubble. From early March 1996 to late September 2000, $ 1.00 invested would have increased to $ 2.26 after peaking the previous month at $ 2.39 – almost identical growth to the current period, with levels of volatility similar. While one does not imagine that the performance of the market in a previous period could predict its movements more than a decade later, it is nonetheless instructive to look at the subsequent decline of the dotted line. Over the next two years, growth stocks led the market lower – the S&P 500 Index fell from the high of $ 2.39, destroying capital and leaving our hypothetical investment to languish at $ 1.28 at the end of the day. end of September 2002.
We prefer a well-designed, carefully implemented, security-focused investment approach. For me, this is the right philosophy and approach to investing. I think it’s the morally right thing to do as a trustee in charge of managing client assets. I believe it is our duty to protect investment capital. We use a value-based stock selection approach and a systematic approach to active risk management. Our focus on dividend paying stocks is intended to provide an additional margin of safety and protect the portfolio from the effects of inflation and market downturns. By focusing on finding value, we seek to identify securities with a higher probability of buying low and selling high. In contrast, growth-oriented approaches attempt to “buy high and sell higher”, often without dividend protection – a recipe for catastrophic investment in my opinion. It is important to mitigate the many behavioral biases that can adversely affect investment results. Irrational decisions made in the face of incomplete information, emotional responses, unequal responses to reward and risk, retrospective bias and overconfidence are issues in the investment landscape, especially when the process of investing. investment is very subjective. On the other hand, we have designed a rational and systematic approach that aims to avoid these problems as much as possible.
Currently I drive a Jeep. It combines all the reliability and reliability benefits of the old Rover with more sports car-like comfort and performance – but without the hassle of either car. It is a safe vehicle. It is a reliable vehicle. It’s the best of both worlds. It gets me where I want to go, in a consistent and comfortable way.
In 2014-2015, could we experience a drop like the one that occurred in 2001-2002? Only time will tell. The best investment approach is designed to get clients to achieve their investment objective primarily by trying to avoid permanent and unacceptable losses of capital. It’s an approach designed to continue to work in all conditions, capturing a fair amount of bull market gains while seeking safer results in choppy and bearish markets.
Craig French is a Portfolio Manager at WBI Investments and can be contacted at www.wbiinvestments.com. The company manages $ 2.3 billion for investment advisers and their clients in high yield, dividend paying equity portfolios.