Can you believe that annuities are not only still hanging around but actually making a comeback thanks to the retirement of the baby boom generation? Ditto for mutual funds. To paraphrase Lee Iacocca, mutual funds have been just too lucrative to fail. At least until now. But an event as catastrophic as the credit crunch will surely have some long-term effects on the financial services industry. One of those effects might finally be the ascendance of exchange traded funds, and along with them, the death knell of modern portfolio management.
One of the only bright spots we’ve seen in the financial services industry during the past six months or so has been those firms offering ETFs that short the markets, use leverage, or track commodities indexes: the established Rydex and ProShares ETF shops, and their newest competitor, Direxion Funds. Assets at all three firms are up, way up: according to data from the National Stock Exchange, last November over $26 billion flowed into ETFs, nearly 43% of all U.S. equity trading. That’s because these firms not only offer the ETF tools that enable advisors to “strategically allocate” portfolios, they also actively don’t discourage the movement of large sums sometimes required by what was formerly known as market timing.
Advisors scrambling to protect client assets from last autumn’s market freefall poured funds into commodities, currencies, and most of all, short funds. What might have been a disaster for the global economy was surely a windfall for ETF platforms. “We don’t like to think of [the down market] as an opportunity,” says Dan O’Neil, president and chief investment officer of Direxion Funds, which nearly doubled its AUM, taking in almost $1 billion in the last two months of ’08, “but we do want to help people make money, especially when other people are losing money.”
Today’s bear market may be putting ETFs on top of the heap because it’s causing advisors to question their buy-and-hold investment strategies based on modern portfolio theory. When I started covering financial advice in the early 1980s, the stock market had been flat for 10 years, inflation was in double digits, and a “well-allocated” portfolio consisted of equal parts real estate, oil and gas, and gold. Then, the Reagan bull market began to gather momentum, resulting in a DJIA climb from under 1,000 to eventually 14,000 in the fall of 2007, a 25-year period during which stocks and bonds have been king. Consequently, a properly diversified portfolio now holds small and large caps, growth and value stocks, some bonds, and intermittently, some international securities, which periodically look very good but seem to invariably end in large losses.
Today, the “accepted allocation” may change again. With the current crisis causing massive global losses across all classes of equities, corporate bonds, real estate, and commodities, advisors are reevaluating their most strongly held investment strategies. How can all investment classes go down at one time? Is inverse correlation between assets a myth? Is diversification? What’s the real lesson here? How do you explain what’s happened to your clients?
When the stock market goes down, buy and hold has always been a bitter pill for clients to swallow. But with sufficient handholding by their advisors, most of them have been able to stay the course and watch their portfolios recover with the economy and the Dow Industrial.
For one thing, there were always some bright spots to point out–small caps were up, or value stocks out performed. For another, historically markets go up a lot more of the time than they go down, so it usually wasn’t long before a recovery started to put smiles on everyone’s faces again.
Is it different this time? Much as those words (which usually precede some really dumb decision) make me involuntarily cringe, in some ways it is. If for no other reason, we’ve never seen such losses across all asset classes and styles, with the only exception being Treasury bonds. Yet there were a few investment professionals who had some or all of their clients’ money in Treasuries.
Yes, I’m talking about strategic allocators, or tactical allocators, or whatever “those people” have been calling themselves since “market timer” went out of vogue.