A few months ago, a friend and fellow advisor expressed his frustration that just at the time that we really needed the benefits of noncorrelated asset class investing, correlations went to one.
It was true: There was nowhere to hide during the financial crisis. That is one of the things that made it so painful.
Now, please don't come after me for saying that MPT is dead or that asset allocation didn't work. Please don't call me a heretic for drawing a sketch about a core tenet of our collective faith. I am just pointing out the fact that I am sure almost all of us found ourselves complaining about:
Just when we need something to zig, they all zagged together!
I know that this was just one event, and one event doesn't refute decades of research, but during this one event, the promise of mixing low-correlated and noncorrelated assets didn't pan out like we all expected.
After you timed the market correctly in 2000, 2002, 2008 and 2009, did you take a well-deserved vacation and go mermaid hunting on your unicorn?
Please break down the next 24 months of market movement for all of us not possessed with your keen futureman skills.
Thank you in advance, world's smartest person.
- Rosetta, St. Louis
September 20, 2009 5:02:48 pm
Right you are, market timing just does not work. And poker is pure luck and the fact that the worlds current #1 poker player, Phil Ivey, will play the final table of the WSOP Main Event in November, overcoming 6,600 other players, is just happenstance. Right.
Let's see, Amerindo Tech D mutual fund makes 256% in 1999 and we are at the end of a huge bull market: it didn't work out to well to pull back sharply and take chips off the table during the 6 month table-top in early 2000. Then after a 50% matket decline, the S&P bounces off of 800 not once but twice in late 2002 (I think they call this a techmical indicator or something like that) and the geo-political concerns vanished as the US waltzed into Bagdhad and the typical bull market period had passed and we had a 6 month bottoming plateau, it was really, really difficult to see that it was time to go back into equities. Then, after a typical 4 year bull market (let's count them shall we, 2003, 2004, 2005, 2006) and various top-notch economic journalists were calling for a crisis and we had another 6 month table-top graph in 2007, it was almost impossible to see that it might be a good time to switch into cash and begin dca (that is something they call dollar cost averaging or even (*gasp*) rebalance into inverse bear funds).
This was all so, so technically advanced that only rocket scientists and brain surgeons could have seen this coming, not some little indi RIA shops run by managers with econ degrees.
You are right, doesn't work, it was all just luck. Stick to buy and hold and don't even entertain the words paradigm shift or sideways markets. I am quite sure your AUM will skyrocket in the coming decades and your clients will be clamoring for more of that kind of good stewardship.
Right.
- Right you are, Cincinnati, OH
September 19, 2009 8:31:24 am
The fact is that not all asset classes were negative. The most liquid and easily obtained asset, US Long Treasuries, did quite well. What was needed was a systematic program of shifting wealth to the best performing assets. It would be nice of market timing actually worked so we could use the poor risk/return performing bear funds as some have suggested. Unfortunately, market timing is imperfect. Avoid the bear funds. Use asset allocation instead.
- pgcpaul, Louisiana
September 17, 2009 11:20:00 pm
Prudent Bear (BEARX) and Profunds Ultrabear domestic and international funds all held up quite well: the new allocation class for use after four-plus-year bull markets.
- Active in Cincinnati, Cincinnati, OH
September 17, 2009 8:52:51 am
Carl, Simple yet effective! Your insight is appreciated. Having read The World is Flat by Thomas Friedman I wonder if technology leveling the playing field didn't cause some of this correlation to converge? Let's face it, it is pretty easy to panic and sell things fast based on emotion rather than letting things sit until you can make a rational Right View decision. Only one factor in a much larger equation, but it could be a biggie!
- Rich Feight, Michigan
September 16, 2009 1:55:32 pm
We would suggest that the scale and velocity of asset correlations have taken a quantum leap upward. Modern Portfolio Theory is simply not modern enough for the current global financial system.
- RichandCo, Chicago
September 16, 2009 12:12:34 pm
@Russ- thanks. I agree that the focus should be on the ongoing PROCESS of planning. Like we have talked about in the past, what people really need is a PLANNER and not just a plan.
- Carl Richards, US
September 16, 2009 12:07:25 pm
Another great sketch, Carl.
And this is another great reason to recognize that risk & return (including asset class correlations) are only one of the factors in a smart financial plan.
While 2008 was painful, it didn't all happen overnight and by regularly reviewing and readjusting other variables like timing of goals and cashflow amounts, you could have kept a financial plan on track regardless of whether correlations are at one or not.
Nevertheless, you're absolutely right. The market (and most things in life) have a habit of doing their own thing when we can least afford for them to.
- Russ Thornton, Atlanta, GA
September 16, 2009 11:22:23 am
Mark, you bring up a great point, there is so much talk about what you can do to deal with year over year [annual] volatility, but that ignores that fact that real people, with real money, don't live annually.
We live our lives daily. We don't experience risk in annual terms...we feel it daily.
- Carl Richards, US
September 16, 2009 11:18:45 am
A deflationary spiral separates all assets into those that gain or lose from inflation/deflation. That is why long bonds went on a tear last year. The decades of research didn't include financial crises in other countries. Think Japan in the early 90's, US in the 30's, etc.
Even investments that were diversified better than any funds out there, like Bridgewater's all-weather portfolio, were down 20+%.
Good crisis protection could include GNMA securities and agency bonds.
- Retirement Savior, US
September 16, 2009 11:04:27 am
How about some healthcare stocks/ETFs? Johnson & Johnson and other consumer health-type stocks didn't budge too much during the crash... in Canada, stocks like CML Healthcare... they didn't go untarnished, but they're the only thing I can think of that was a place to hide, and I was wishing I'd had more of my $ in them. Overall I agree with your point, though, it's amazing that that diversification theory didn't hold up very well at all.
- MoneyEnergy, U.S.
September 16, 2009 11:03:05 am
In an interview on WealthTrack, David Swenson provided what I thought was a good explanation.
He argued that during a crisis, investors flee from any investment with any risk. Meaning that people sold stocks, real estate, corporate bonds, etc. ...and all of that money went into short-term U.S. Treasury debt.
It sounded to me as if he was making the case that diversifying across asset classes helps with your typical year-to-year volatility, but when things really get ugly, this sort of thing will happen every time.
- Mike Piper, Chicago
Post a Comment
Comments are moderated and generally will be posted if they are on-topic and not abusive.
Follow us on Twitter
