Stocks May End 2023 Higher After Bumpy Trip: Dana D’Auria

Dana D’Auria, co-chief investment officer and group president at Envestnet Solutions, suggested recently that stocks may end the year higher, albeit with significant ups and downs along the way.

D’Auria, who became co-CIO in 2020, recently shared her thoughts on financial markets, the economy, investing strategy and client portfolios, and a bit about herself. Here’s a lightly edited version of her email Q&A with ThinkAdvisor.

THINKADVISOR: Where do you think stocks will finish the year?

DANA D’AURIA: Predicting short-term equity movements is always a shot in the dark. There’s too much noise around the signal. While I think a recession is the likely bet, stock returns are leading indicators that have already priced in what is known about economic risks.

Interestingly, equities also tend to end in the black in the year after midterm elections. So, my qualified response is that equities will end the year up by around 10%. My expectation is that wherever we land, it will not be without considerable ups and downs.

What has been your best prediction in the past year or so?

My best prediction has been that we would see a return to fundamentals, in particular a rotation to value stocks away from growth, that would be driven in part by a move away from an era of free money to one in which the cost of capital is once again a material consideration.

Growth stocks benefited dramatically from a decade of very low interest rates because their longer-dated cash flow contributions to current value were discounted by lower numbers. With a higher discount rate to factor in, companies with longer duration would tend to fare more poorly. And that has played out.

What has been your worst?

Small cap stocks, which have tended to be good inflation hedges over time and long-term outperformers when you excise the growthiest parts of the market, did not perform very well last year. Many investors think of the S&P 500 as the “market,” but I believe a well-diversified portfolio should have at least market cap weight to small cap.

Significant academic evidence on style factor anomalies concludes that small cap value stocks substantially outperform over time. But whenever you accept tracking error, you take the risk of a long period of underperformance.

What is your No. 1 piece of advice to investors?

Diversify. It is the one free lunch in investing. The more uncorrelated assets you have, the more you can lower the volatility of your portfolio for a given level of expected return.

If you want to measure the return of a portfolio of assets, you add up the weighted average return of each of the holdings. But if you want to calculate the standard deviation, or volatility of that portfolio, you don’t just add up the weighted average standard deviation of each holding. The overall portfolio volatility will be lower than the weighted average of the volatilities of the underlying because of the benefits of diversification.

And if the math doesn’t impress you, just consider the dispersion risk of individual stock holdings. Yes, you may have a few top performers, but you also may end up with bottom performers and, particularly in a bad market, the difference in outcome can be catastrophic. For most people, investing for retirement or other long-term goals, taking that kind of risk with their nest egg doesn’t make sense.

The index of all names is always going to be somewhere in the middle.

What are you telling advisors to do differently with portfolios this year, or what strategy do you suggest they follow?

My advice to advisors is to look at the many ways they can personalize their client portfolios at scale. Technology has opened up so many doors to better investment opportunities for clients. Whether it be tax overlay services that can be customized to the client’s own capital gains budgets or sustainable investing solutions that allow clients to incorporate some social preferences, advisors have many options in the toolkit to provide investors of all asset levels with a custom engagement.

We know that client discipline in an investment is a major source of long-run better outcomes. Advisors cannot control market outcomes, but they can personalize client investments such that the investor is more likely to hang with it through the inevitable bad times.

Whom do you follow on social media and why?

I’m not a big social media consumer. I tend to listen to individual podcasts that are recommended to me or related to a topic I am researching or thinking about at the time. In terms of thinkers in our industry, Eugene Fama, Ken French, Cliff Asness and John Cochrane are favorites.

What do you do to take a break from the markets?

I like to do The New York Times crossword puzzle every day with my husband. It’s a great way to decompress and let your mind focus on a fun distraction.

What do you like the most and least about your job?

I have the immense luck to work for a company I love with great people doing a job that keeps me engaged, learning, innovating and connecting to brilliant people in our industry. It’s that continuous engagement with others and learning from them that I like most.

(Pictured: Dana D’Auria)