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Portfolio > Asset Managers

The Big Picture

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The last two years have provided a wild and turbulent ride for the markets, investors, advisors, and investment managers alike. Many portfolios with a riskier profile suffered horrible losses in the 2008 global meltdown. Portfolios that were positioned less aggressively and avoided some the downside of 2008, or that moved to cash at year-end, were left in the dust of the incredible rally of 2009.

For advisors that make heavy use of third-party investment managers in building their clients’ portfolios, the large dislocations of the last two years can cause many problems, not the least of which is understanding how effectively managers navigated the markets and how to explain performance to clients.

When evaluating managers for use in a client’s portfolio it’s important to understand how those managers invest the capital they are given. Seeking the best absolute performance going forward is an admirable goal, but time and again it has been proven to be virtually impossible to do with the historical information we have available. This does not mean that the information we have is worthless, but we have to be able to look past the simple metrics of whether a manager beat or underperformed their benchmark. It’s important to help our clients understand that most of a manager’s returns will come from what they invest in (asset class, style, security type, etc).

The last two years exhibited major shifts and swings in the markets. Most long-only managers were caught in one side of the swing or the other: 2008 was the year of fear and the markets only rewarded the safest of safe investments, namely Treasuries. Any manager who did not invest a significant portion of their portfolio in either Treasuries or cash fell significantly. The higher the perceived risk, the further they fell. Most equity indices were down 30% or more in 2008. Many investors were shocked to see their relatively safe bond portfolios down 5% to 10%.

The exact opposite of 2008 occurred in 2009 as investors’ appetites for risk were restored. The riskier a security seemed, the more the price increased, and 2009 may be represented as the “Dash to Trash.” This may be best illustrated by examining one of the riskier asset classes, the high yield bond market. As a group, high yield bonds were up almost 60% for the year, according to Barclays U.S. Corporate High Yield Index. However, the most risky and lowest credit quality subset of the universe, those bonds that were rated Ca to D, were, according to the Barclays U.S. Corporate High Yield Index, up almost 140% on the year! It was a similar story across virtually every area of the market. The astounding index returns we saw in 2009 were largely driven by the riskiest securities.

As far as equities are concerned, many of the highest quality long-only managers invest with a relatively long time horizon and are particularly prone to get caught in violent market swings. Managers that tend to believe that the highest quality companies will succeed in the long term were able to dampen their losses in 2008 but were unable to keep up in 2009. For example, the Eaton Vance Large Value fund (EILVX) has established an excellent long term track record by finding stocks that have strong fundamental characteristics, and by following a strict sell discipline that forces stocks out of the portfolio if losses or gains exceed certain thresholds. This discipline helped them to avoid some of the losses that their benchmark and peers suffered in 2008. This same discipline, however, constrained their performance in 2009.

Thornburg Value Fund (TVIFX) employs an investment process that allows the managers to be much more opportunistic. As the market (in their view) unfairly punished securities in 2008, Thornburg stepped in and purchased them at what they perceived to be very low prices. Those low prices continued to drop throughout the year and pushed this fund further down than both its benchmark and its peers. These same securities then led Thornburg to stellar 2009 returns.

All of us can use the last two years as a valuable teaching experience. It’s easy for both clients and even wealth managers to lose the forest in the trees. We all know that we should be focused on the entire wealth picture, but it’s easy to get caught focusing too much on the raw performance of one piece of the portfolio. Instead, the focus needs to be on how the entire portfolio is constructed and works together. We, as wealth managers, need to continue to help our clients set appropriate wealth goals, document those goals, and develop a plan to achieve these goals. By focusing on the big picture we can help our clients, and ourselves, better absorb the mania of the market.

J. Gibson Watson III is president and CEO of Denver-based Prima Capital (, which conducts objective research and due diligence on SMAs, mutual funds, ETFs and alternatives.


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