After an AWOL month, Keeping Score is back with an analysis of S&P 500 performance for July, as well as for the past 12 months.
I’ve just updated my Keeping Score page. May as a rebound month.
I’ve just updated my Keeping Score page for Janaury.
1. Most US equity managers, prompted by personal inclination and the wishes of their employers and their institutional clients, adopt either a value (buying undervalued assets) or a growth(buying accelerating profit growth) investment style. In a typical business cycle, the first two years favor value stocks, the latter two growth issues. Over that cycle, a manager is likely to have two good years, one so-so year and one bad year. A skilled manager, however, will outperform over the cycle sc s whole, no matter what his style is.
This is another way of saying that the criterion of outperforming every year is unreasonable.
2. a truism: the pain of underperformance lasts long after the glow of outperformance has faded. A manager who builds a riskier portfolio expecting fame and fortune from significant outperformance risks exploding on liftoff and outperforming badly–thereby losing both his clients and his job. He also gives his firm a significant black eye. No one, however, gets fired for underperforming slightly and being in the middle of the pack of competitors.
As a result, many long-lived investment organizations are constructed on the idea of strong marketing and so-so performance. I’ve always regarded Merrill as the poster child of this approach in the mutual fund arena.
In other words, outperformance isn’t the most important attribute of a successful investment product.
3. Most investment organizations find that a running a research department of their own is difficult and expensive. Many, especially (in my view) the majority which are run by professional marketers, have long since eliminated proprietary research and have been depending heavily on brokerage houses to supply this service. Doing so has the additional advantage that in-house analysts are no longer a drain on management fees received (brokerage house research is paid for with clients’ commissions). That “solved” a problem and enhanced profits at the same time.
However, brokerage houses gutted their research departments during the market downturn in 2008-09. The sharp decline has also accelerated an ongoing trend away from traditional investment managers and toward a diy approach using index funds.
So there’s no longer a plethora of high-quality brokerage reports and no “extra” management fee money to reconstitute proprietary research departments. Where are the good new ideas going to come from? I think this new client preference for investment performance over salesmanship will create severe difficulties for traditional investment organizations.
I’ve just updated my Keeping Score page for a sideways-moving S&P in December.
I’ve been thinking about the Mainstay Marketfield fund. The I shares (the ones with the longest track record) = MFLDX.
Is this a risky fund?
A lot depends on what you mean by “risky.” And a lot depends on the time frame you use.
The standard academic way of assessing risk is to equate it with the short-term volatility of returns. The idea has some initial plausibility. All other things being equal, and for everyone besides roller coaster junkies, a smooth ride is better than a bumpy one. Greater assurance that the price tomorrow isn’t going to deviate much from the price today sounds good, as well.
The main virtue of risk-as-volatility, though, is that it’s easily quantifiable and the data for measuring it are readily available. There’s no need to delve into the actual investments and make potentially messy judgments about what a security/portfolio is and how it works, either.
On this way of looking at things, MFLDX isn’t risky at all.
During late 2008 – early 2009 the fund declined less than the S&P 500. From the beginning of the bull market in March 2009 until mid-2013 it tracked the S&P relatively closely. Less volatile in down markets, average volatility in up markets. Not a bad combination–if this is all risk is.
Regular readers will know that I’m not a fan of this academic orthodoxy–which is, by the way, also universally accepted by the consultants who advise institutional pension plans. It isn’t only that you don’t need any practical knowledge of the products you’re assessing–just a computer and a data feed. Nor is it that my portfolios routinely had part of their excess returns explained away by their greater-then-average volatility. No, it’s that, in my view, for an investor with a three-, five- or ten-year investment horizon whether a security goes up/down a little more or a little less than the market today and tomorrow has very little relevance.
Risk-as-volatility has done serious damage in financial markets in the past. For years, academics and consultants regarded junk bonds as relatively safe because their volatility was close to zero. They didn’t realize that the prices never moved because the securities were highly illiquid and seldom traded. In fact, during the 1990s, i.e., even after the junk bond collapse of the late 1980s, Morningstar continue to have junk bond funds in the same category as money market funds. Since NAVs never moved, the former got all the highest ratings.
Back to MFLDX.
Suppose we look at the fund in a commonsense way.
Marketfield’s website portrays ithe firm as consisting of three principals who concentrate on macroeconomics. The career descriptions indicate that only the director of research, who arrived in 2011, had any prior portfolio management experience.
The group runs a highly sectorally concentrated portfolio. MFLDX can be both long and short. It has a global reach. It can own/sell short stocks, bonds, currencies, sectors, indices.
Despite having all these potentially return-enhancing weapons at its disposal, the fund was unable to outpace an S&P 500 index fund during the first four years of the bull market.
Yes, short-term price fluctuations were not extreme. And I’m not saying that one could have predicted that MFLDX would be down 12% in 2014, in a market that is up 13%–sparking massive redemptions. But it seems to me that risk-as-volatility didn’t come anywhere near to capturing the risk elements present in this fund.
Too much traffic and too much last-minute bricks-and-mortar shopping mean that I’m only getting around to this post late in the day ..and that this one will be short.
Reports I’ve been reading over the past month or so say that 2014 will turn out to be a very bad year for active equity managers, in two senses:
–a larger proportion of managers than normal are underperforming their benchmarks. The figure I’ve heard tossed about is a whopping 85% vs. a more “normal” 65%;. Also,
–the degree of underperformance is more severe than in typical years.
I’m assuming that the 85% is before fees. The ideas that underperformance is worse across the board than normal suggests that the number of underperformers before fees could be as high as 75% – 80%.
–since investing is a zero-sum game, whose pockets are filling up with the money active professional managers are losing to the index?
–wha makes this year so different?
Since index funds by definition neither win nor lose vs. the index, the underperformance of professionals must end up either as fee income for middlemen (brokers, marketmakers) or dor investors who don’t publicize their returns. The largest portion of the latter class is individuals, although I find it hard to believe that you and I are beating the index by enough to make such a big dent in professionals’ results. On the other hand, I have no better answer.
The second point is more interesting, I think. On a sector basis, I suspect that professionals had too little IT and too much Energy. 2014 has been a recovery year for large-cap last-generation tech like MSFT (+28%) and INTC (+44%). AAPL, which makes up 3.5% or so of the S&P is up almost 40%, as well. Not having these names would have been costly. As to Energy, it’s possible that many pros bet heavily on rising crude oil prices through offshore drilling companies and unconventional oil sources like tar sands and shale oil–all of which would make the holder exceptionally vulnerable to price declines.
ln my strategy posts, I suggested that, because 2015 would be the first year in a long time in which government policy would not be clearly stimulative around the globe, the fundamental question of whether the near-term market direction will be up or down won’t obviously be “UP” for the first time since early 2009. Not knowing in advance whether to be aggressive or defensive would make portfolio structuring that much more difficult.
In hindsight, maybe the first year of no one-way bet has been 2014. If so, it’s possible that this year’s performance by pros isn’t the outlier. Maybe 2010-13 are. I wonder, in other words, if this year’s poor active manager performance is a harbinger of what the future has in store.
More on this topic after Christmas. Now to present wrapping.