|S&P 500 Index*||1.79%||3.44%||14.57%||Large-cap stocks|
|Nasdaq Comp.*||4.35%||11.56%||35.56%||Large-cap tech stocks|
|Russell 1000 Growth||2.49%||5.04%||18.78%||Large-cap growth stocks|
|Russell 1000 Value||1.56%||3.07%||14.99%||Large-cap value stocks|
|Russell 2000 Growth||5.37%||13.34%||35.25%||Small-cap growth stocks|
|Russell 2000 Value||3.80%||8.98%||26.94%||Small-cap value stocks|
|MSCI EAFE||2.43%||4.93%||15.26%||Europe, Australasia & Far East Index|
|Lehman Aggregate||0.66%||-2.72%||1.10%||U.S. Government Bonds|
|Lehman High Yield||1.15%||0.04%||18.53%||High-yield corporate bonds|
|Carr CTA Index||1.98%||0.24%||10.47%||Managed futures|
|3-month Treasury Bill||.||.||0.72%|
|Through August 31, 2003. *Return numbers do not include dividends.|
The investment world received a shakeup earlier this year when market guru and well-known consultant Peter Bernstein, author of such well-received books as Against the Gods and Capital Ideas, spoke at a conference for pension plan administrators in Phoenix at the end of January. The erudite Bernstein noted that, owing to the ever-decreasing dividend rate and reduction in the equity risk premium, the future returns of equities will in no way resemble their long-run performance. His solution to the vexing problem of dwindling asset returns–market timing–roiled the usually timid institutional investors in attendance.
Market timers are those folks who claim that, by using a mixture of fundamental and technical analysis, it is possible to generate a higher return with less risk than passive indexing. Efficient marketers represent the flip side of the argument, claiming that an always-invested approach beats an in-and-out strategy. So who’s right?
The answer, of course, is probably somewhere between these two extremes. Portfolio activity such as regular rebalancing incrementally adds to returns, for example. And there’s little doubt that the less efficient areas of the capital markets, including the high-yield debt and international small-cap arenas, are better navigated by active managers than by passive indexes.
Many view Bernstein’s comments as a market timer call to arms. I see it as a natural reaction to the institutional investment process, vetted ad nauseam through one committee after another, that serves no purpose except to minimize liability at the expense of return.
After all, institutions and pensions base their decisions on asset allocation, which is determined largely by the long-run returns of each asset class. But what if past performance is not indicative of the future? According to Bernstein, equities will likely prove to be a disappointment for the next decade or so–a situation faced by investors several times in the last century–and as a result, it may not be wise to commit the bulk of one’s assets to that arena. In his view, the best returns will come from the development of an opportunistic mindset, moving deftly from one asset to another based on expected returns.
RIAs would have a tough time adopting this mindset. Considering the dismal track record of most open-end mutual funds, the transfer of the types of risk generated from such an investment process could be devastating. Hedge funds are another idea, but accessing quality managers continues to be a tough proposition.
The path that investment advisors take will represent the next phase of the wealth management industry. I envision mandates that have specific risk and return objectives, but will be more open-ended regarding the exact method RIAs will need to take to achieve them. I also expect a bigger emphasis on controlling downside risks at the portfolio level, either by increased diversification or the use of derivatives.
I don’t believe that either of those strategies can be adequately described as market timing. Rather, they can be viewed as truly evolutionary changes that the investment industry must adopt in order to achieve the objectives of our diverse client base.