Do the terms “upward sloping equity glide paths” and “bond tents” seem unfamiliar to you? They are terms that financial planning researchers are using to describe investment strategies designed to mitigate “sequence risk,” the risk that your portfolio returns will occur in the wrong order, thereby negatively impacting the amount of income your retirement account will generate. Pinnacle’s Director of Wealth Management, Michael Kitces, writes an interesting article on the subject in this month’s OnWallStreet, titled, “Avoid the Retirement Danger Zone.” (You can read the article by clicking here.) Since most Pinnacle clients fall in the age range of 50 to 70, where pre-retirement and early post-retirement risk is the highest, and since the recent election has clients questioning recent portfolio volatility (in this case, to the upside), it seems a good time to revisit the question of whether active portfolio management still makes sense.
If you are looking for a movie about power, money, sex, drugs, yachts, Lamborghinis, high-pressure sales tactics, stock manipulation, sex, and drugs (did I mention sex and drugs?) then go see the new Martin Scorsese movie, The Wolf of Wall Street, starring Leonardo DiCaprio. The film is based on the memoirs of Jordan Belfort, the founder of the brokerage firm Stratton Oakmont, which functioned as a boiler room selling penny stocks in the 1990s. I don’t want to give away the ending, but I will say that if you enjoy watching unimaginable amounts of corruption and debauchery, you are going to love it.
All of which gets me thinking about the admittedly boring world of our Pinnacle investment analysts.
In a recent “Your Money” column in the New York Times, John Wasik did a great job of delivering the status quo message about portfolio expenses. He reminds us that John C. Bogle, Founder of the Vanguard Group, and many others, have performed studies that demonstrated that active managers cannot beat a passive index because of the fees charged in actively managed funds. He reminds us that these consist not only of the well-known and often discussed fees in a fund’s expense ratio, but also include ‘hidden’ fees like the cost of managers who leave too much money in cash (which does not earn market returns), and fund transaction costs. The article goes on to mention a recent paper by William Sharpe, the Nobel Prize winner this year in Economics, who compared the expense ratio of Vanguard’s Total Stock Market Index Fund to a more expensive actively managed fund, and found that the costs of active management were $2,000 for a $10,000 investment over ten years.
I have been on the road quite a bit recently, appearing at several professional conferences around the country. One fellow speaker at a conference in San Diego was Dr. Christopher Geczy, a finance professor at the Wharton School and the new academic director of the Wharton Wealth Management Initiative. His impressive resume features a B.A. in economics from the University of Pennsylvania and a Ph.D. in finance and econometrics from the Graduate School of Business at the University of Chicago. Professor Geczy’s talk was both much anticipated and well received.
The way we explain our process for managing portfolios has significantly changed over the past few years. It seems that both retail and institutional investors want to hear more about how ‘the sausage is made’ than they did a decade ago. And why not? The financial markets have been difficult to navigate since the market topped in the year 2000 and good consumers want to know how we might fare if the markets remain challenging in the future. While I appreciate the work that has gone into fine-tuning our message, one aspect of our investment process is just as relevant as it was when we started tactically and actively managing portfolios in October 2002: We try to find investment opportunities that have a great story.
Just two days ago the 4th quarter GDP came out as a negative number, which was much worse than expected. In fact, not one of 83 analysts had anticipated a negative number, meaning they were all too bullish on the 4th quarter growth number. But yesterday the Chicago Purchasing manager’s index, a growth barometer, was way above expectations for growth, and not one of 48 analyst estimates was in the ballpark, meaning they were all too bearish on growth.
In my last column, I described a bearish scenario where the markets come to the realization that the monetary authorities are out of bullets. This was simply an exercise in critical thinking and doesn’t actually line up with our current forecast, and I did promise I would come back with a bullish scenario.
Most Pinnacle Advisory Group clients are familiar with our view of secular (or very long-term) market cycles. My partner, Michael Kitces, and I first published a paper on secular bear markets in the Journal of Financial Planning in 2006, where we predicted correctly that stock prices were likely to deliver much less than average returns for years to come. In my 2009 book, Buy and Hold is Dead (AGAIN): The Case for Active Portfolio Management in Dangerous Markets, I reviewed in some detail the rationale for why stock prices can disappoint investors ‘on average’ for decades. (In fact, the “(AGAIN)” in the book title referred to the fact that we’re currently laboring through the fourth secular bear market since the 1900’s.)
October 31rst marked the ten-year anniversary of Pinnacle’s Global Investment Performance Standards (GIPS) compliant track record. That’s a big deal in the institutional investment community — it means that we’ve met the GIPS standard for reporting performance (often required by institutional investors). It also means that we have a legitimate ten-year track record, which is a long time in the investment business. If nothing else, we can show investors our performance over several different market cycles, which is a very useful way to evaluate a firm’s investment process. Importantly, we also have the same investment team today that we had a decade ago. After all, what good is a ten-year track record if the analysts who are responsible for the past returns are no longer at the firm?
“Is poker more a game of skill or of chance?”