News

And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward.
Larry Fink, CEO, BlackRock, January 14, 2020

We find that firms with good performance on material sustainability issues significantly outperform firms with poor performance on these issues, suggesting that investments in sustainability issues are shareholder-value enhancing.
Mozaffar Khan, George Serafeim and Aaron Yoon
Corporate Sustainability: First Evidence on Materiality

The more concentrated a portfolio is, the greater the risk of missing out on the market’s biggest winners and underperforming. This risk is greater among mid- and small-cap stocks than it is among large ones.
Alex Bryan, Morningstar, “Why Diversification Beats Conviction”

Quick Year in Review
2019 was a really good year, as evidenced by the indices we follow below.

Coming off a dreadful 4th quarter of 2018, there was not a lot of optimism. The Wall Street Journal Online ran the following headline on January 1, 2019.

“U.S. Stocks Face Rocky Path Ahead in 2019; Many fund managers say they expect more volatility with the bull market in doubt”

In the Wall Street Journal’s Year End Review on January 2, 2019, the headline was:

“Year-End Review & Outlook (A Special Report): Markets & Finance — Weak 2018 Finish Testing Investors’ Faith in Stocks”

It is a good thing we did not bail from the markets in 2019 based upon those headlines!!! The results show that predicting short-term returns is a fools game, and it is important to be broadly diversified and have the appropriate risk allocation for your financial plan and risk appetite.

Fast forward to the 4th quarter of 2019, equity markets around the globe posted positive returns. Looking at broad market indices, US equities outperformed non-US developed markets but underperformed emerging markets.

Value stocks underperformed growth stocks in all regions. Small caps outperformed large caps in the US and non-US developed markets but underperformed in emerging markets.

REIT indices underperformed equity market indices in both the US and non-US developed markets.
Here is a graphical look at the MSCI All Country World Index for the year, plus an inset showing performance of the Index since 2000.

Diversification

We continue to beat the drums on diversification. Recent data from Societe Generale’s Andrew Lapthrone noted that just 1 in 5 of 16,000 global stocks outperformed the S&P 500 over the past 2 years. It is virtually impossible to know what those 1 in 5 will be in advance. Consequently, it is much better to be broadly diversified. Not only are your returns likely to be better, but because your investments are spread among many companies around the world, your return to risk ratio will also be better.

Larry Fink of BlackRock on Sustainable Investing

The world of investing is starting to change. Larry Fink, the CEO of the largest asset manager BlackRock, made the national news last Tuesday, and not just the business news. He issued a letter on January 14 to CEOs regarding how BlackRock is going to invest its $7 trillion in money going forward (see full letter here https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter). BlackRock will no longer invest in thermal coal producers in BlackRock’s actively managed portfolios, and it will be increasingly disposed to vote against management and boards of publicly traded companies if the companies do not disclose climate change risks and plans in line with key industry standards. As Fink stated in his letter:

“In a letter to our clients today, BlackRock announced a number of initiatives to place sustainability at the center of our investment approach, including: making sustainability integral to portfolio construction and risk management; exiting investments that present a high sustainability-related risk, such as thermal coal producers; launching new investment products that screen fossil fuels; and strengthening our commitment to sustainability and transparency in our investment stewardship activities.”

“Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.”

Jeremy Grantham, founder of Grantham, Mayo, & van Otterloo and one of the foremost capitalists of the last 50 years, has made a marked push to more sustainable investing. In an interview last week, referring to the oil industry, he stated “the last 10 years it’s up 5% and the S&P has tripled. Coal has been even worse, and it is going out of business. It has been put on notice.”

The numbers are worse than Grantham indicates. While the S&P 500 was up 13.56% annualized over the past 10 years ended 12/31/2019, according to Morningstar, the returns for the Oil and Gas and Coal sectors over the same period were dismal:

Oil and Gas Integrated Sector     1.59% annualized

Thermal Coal Sector          -7.24% annualized.

Does it make sense to invest this way? According to recent research published in the Journal of Portfolio Management (The Journal of Portfolio Management July 2019, 45 (5) 69-83), it appears that improvement in ESG scores results in improved valuation as mediated by declines in systematic (lower costs of capital) and specific risk (reduced incidence of tail risk events) profiles. This is consistent with George Serafeim’s research at Harvard that “good performance on material sustainability issues are shareholder-value enhancing.”

Our friends at Dimensional have been investing sustainably since 2008. Comparing Dimensional Fund Advisor’s US Sustainability Core 1 Portfolio versus its similar Core Equity 1 Portfolio, as you can see, performance over the past 10 years in their actual mutual funds has not been materially different, and has actually been slightly better for Dimensional’s Sustainability Portfolio. However, the reduction in emissions from greenhouse gases and reserves is dramatically lower as shown in the slide below.

One does not have to give up returns in real life to invest pursuant to Larry Fink’s direction. If you are interested, we have taken our evidence based portfolios and added a sustainable, ESG layer to them. Visit our website here for more info. https://mccwm.com/investing-for-a-better-tomorrow/ We are happy to answer any questions you may have regarding the approach.

Until next time,

Mike and Emily

“We find no evidence that inverted yield curves predict stocks will underperform Treasury bills for forecast periods of one, two, three, and five years.”
Eugene Fama and Ken French

“The Death of Equities: How Inflation Is Destroying the Stock Market.”
Headline – Business Week – August 13, 1979

“The biggest risk facing investors is not short-term volatility but, rather, the risk of not earning a sufficient return on their capital as it accumulates.”
John Bogle

Quarterly Summary
Below are the indices we follow.

As you can see, the quarter was mixed.  US equities outperformed non-US developed and emerging markets during the third quarter. Value stocks outperformed growth stocks in the US but underperformed in non-US and emerging markets. Small caps outperformed large caps in non-US markets but underperformed in the US and emerging markets.

YIELD CURVES, RECESSIONS AND INVESTING

There is a lot of noise surrounding inverted yield curves.  The topic has even made the headlines of the nightly news. The 3 month treasury bill rate has been greater than the 10 year bond rate recently.  Normally, longer dated maturities will have a higher rate. Inverted yield curves are a predictor of recessions, and the inversion occurs on average about 14 months before the onset of recession. See the yield curve as of Thursday, October 3, 2019.

The better question for investors is should they change their asset allocation as a result of an inverted yield curve. The answer is NO.  Nobel Prize winner Gene Fama and Ken French just published a paper on the topic, and they concluded:

“We find no evidence that inverted yield curves predict stocks will underperform Treasury bills for forecast periods of one, two, three, and five years.”

Below is a good link to an article in Fortune with a bit more detail. https://fortune.com/2019/08/13/recession-benchmark-timing-stock-market/

Here is a link to their academic paper. https://famafrench.dimensional.com/media/467645/inverted-yield-curves-and-expected-stock-returns-july-28-2019.pdf

It is important to take a long-term view, and don’t take your investment advice from the nightly news anchor! As you can see by the second quote above at the top of this newsletter, the mass media really does not have a good record predicting long-term returns.

TIMING ISN’T EVERYTHING (A piece from Dimensional Fund Advisors)

A neighbor or relative might ask about which investments are good at the moment. The lure of getting in at the right time or avoiding the next downturn may tempt even disciplined, long-term investors. The reality of successfully timing markets, however, isn’t as straightforward as it sounds.

OUTGUESSING THE MARKET IS DIFFICULT

Attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time presents investors with substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, a daily average of $462.8 billion in equity trading took place around the world.[1] The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.

Dimensional recently studied the performance of actively managed mutual funds and found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.[2]

Further complicating matters, for investors to have a shot at successfully timing the market, they must make the call to buy or sell stocks correctly not just once, but twice. Professor Robert Merton, a Nobel laureate, said it well in a recent interview with Dimensional:

“Timing markets is the dream of everybody. Suppose I could verify that I’m a .700 hitter in calling market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not. But if they were, that’s 0.7 times 0.7. That’s less than 50-50. So, market timing is horribly difficult to do.”

TIME AND THE MARKET

The S&P 500 Index has logged an incredible decade. Should this result impact investors’ allocations to equities? Exhibit 1 suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 went on to provide positive average annualized returns over one, three, and five years following new market highs.

CONCLUSION

Outguessing markets is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence that it can be done reliably, even by professional investors. The positive news is that investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things they can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) investors can better position themselves to make the most of what capital markets have to offer.

All the best,

Mike and Emily

P.S.Here is a good short video from Nobel Prize Winner in Economics Gene Fama on reacting to markets. Less than 2 minutes. Enjoy. https://videos.dimensional.com/share/v/1_1tsep52t

[1]. In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.

[2]. Mutual Fund Landscape 2019.

“All commissioned salesman have a tendency to serve the transaction instead of the truth.”
Charlie Munger

“I think it is inhumane to put people in a strong conflict of interest situation and expect them to behave well.”
Dan Ariely

“Edward Jones as a firm does not act as a fiduciary,” an [Edward Jones] advisor wrote to the CFP board, according to a person who shared details of this and other letters. “Can you provide light on my situation? Will I be forced to choose between my designation or the firm where I have worked for more than 20 years?”
https://onwallstreet.financial-planning.com/news/will-edward-jones-stop-advisors-from-using-the-cfp-designation

Market Review

Below are the indices we follow.

Stock markets around the globe posted positive returns for the quarter. Looking at broad market indices, US equities outperformed non-US developed and emerging markets during the quarter.

Value stocks outperformed growth stocks in emerging markets but underperformed in developed markets, including the US.  Small cap stocks underperformed large caps in all regions. REIT indices underperformed stock market indices in both the US and non-US developed markets.  Below are some visuals of performance.

Fiduciary Duties and Reg BI – Why Hire a Registered Investment Adviser Instead of a Broker?

As a Registered Investment Adviser, McCartney Wealth Management takes its fiduciary duties very seriously and has always looked suspiciously at the conflicts of interests of brokers.

The Securities and Exchange Commission, our regulator, issued new rules known as Reg BI (for “best interest”)  in June that go into effect next year. They are intended to provide investors with peace of mind in dealing with brokers, whose duty to investors has historically been lower than the duties of registered investment advisers such as McCartney Wealth.  The regulation unfortunately does not eliminate conflicts of interest of brokers, which occur when an individual’s personal interests diverge from their professional or moral responsibility to others. The new regulation does strengthen “disclosures” of conflicts, but as you will see below, research has shown that can be worse than no disclosure at all.

The Washington Post’s April 30, 2019, article on political spending shows what the broker world is trying to protect as they compete with Registered Investment Advisers, as the “financial sector spent close to $2 billion on lobbying and campaign contributions in the 2018 election cycle, a 36 percent jump from the last non-presidential campaign year, according to a new report released Tuesday.” There are some steep profits in commissions and revenue sharing.

It is important to note the distinction between brokers and investment advisers. Broker-dealers, or “brokers,” are usually commission salespeople who sell securities and investments. Common brokers are Edward Jones, Stifel, Wells Fargo Advisors, Merrill Lynch, JP Morgan, Morgan Stanley, etc.  They do not have a fiduciary duty to their clients, meaning they do not have to do what is “best” for their clients, but only what is “suitable”.  You will never hear a broker tell a client that they “don’t have to do what is best for them.”  When we review portfolios of new prospects who are coming from brokers, we almost always see high-cost mutual funds with revenue sharing going to the broker selling the mutual fund, along with 12b-1 marketing fees.

The primary job of brokers is to sell products, either manufactured and managed in-house mutual funds, or mutual funds or other products that pay shelf-space fees disguised as “revenue sharing” arrangements, or “shared asset” management fees (separate account management programs), or investments the company has purchased for its own account that it no longer wants to own (proprietary trading activities).

A Registered Investment Adviser such as McCartney Wealth Management by law has a fiduciary duty towards its clients and sells advice, not products.  It has to do what is best for its clients, and must put its clients’ interests ahead of its own. The distinction is very clear.  Supreme Court Justice Harlan Fiske Stone wrote in 1934:

“I venture to assert that when the history of the financial era which has just drawn to a close comes to be written, most of its mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that “a man cannot serve two masters.””

The late John Bogle of Vanguard wrote:

“The fiduciary acts at all times for the sole benefit and interests of another, with loyalty to those interests.”

In fact, our United States Supreme Court has itself opined on Registered Investment Advisers’ fiduciary duties to clients in the 1963 case, Securities and Exchange Commission v. Capital Gains Research Bureau, Inc.  In the case, the court referred to a report issued by the Securities and Exchange Commission that led to the Investment Advisers Act of 1940:

“that investment advisers could not “completely perform their basic function — furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments — unless all conflicts of interest between the investment counsel and the client were removed.”

The Supreme Court continued:

“And the Committee Reports indicate a desire to preserve “the personalized character of the services of investment advisers,” and to eliminate conflicts of interest between the investment adviser and the clients as safeguards both to “unsophisticated investors” and to “bona fide investment counsel.”

Reg BI falls short in a number of ways:

1. It does not define what “best interest” means, so a broker cannot know what his or her duty really is.
2. The SEC believes more disclosure is the answer, although as anyone can see from the Supreme Court case above, eliminating conflicts is the real answer, and not more disclosure.

In fact, Professor Daylian Cain from Yale found in his research that when disclosure of conflicts of interests are provided at the outset of a relationship, brokers “will actually feel more emboldened to provide conflicted advice.”  This alone should mandate avoiding conflicts versus disclosing conflicts.

Charlie Munger advises “never, ever, think about something else when you should be thinking about the power of incentives.”  Incentives drive behavior, and commissions and hidden revenue sharing arrangements of brokers put investors in high cost, sub-optimal products. Professor Cain states “Conflicts of interest are a cancer on objectivity. Even well-meaning advisers often cannot overcome a conflict and give objective advice. More worrisome, perhaps, investors usually do not sufficiently heed even the briefest, bluntest and clearest disclosure warnings of conflicts of interest.”

What is the answer for someone seeking investment advice?

Avoid brokers and hire a “fee only” (no commission) Registered Investment Adviser. If you ever have any concerns whether your adviser is a fiduciary, ask that they confirm their fiduciary duty to you in writing.

Until next time,

Mike and Emily

“Many investors are bracing for further turbulence in the stock market in coming weeks, with few expectations that the dramatic swings will subside soon, given uncertainty over the economic and interest-rate outlooks.  ‘The market is vulnerable right now,’ said Terri Spath, chief investment officer of Sierra Investment Management. ‘A number of technical indicators have broken down, making it hard to call for any sort of bottom.”
Wursthorn, Michael. Wall Street Journal, Eastern edition; New York, N.Y.  03 Jan 2019: B.1

Investors Rush to Buy Up Stocks — As rally powers major indexes toward record, traders are wary of missing out on gains
Ramkumar, Amrith. Headline, Wall Street Journal, Eastern edition; New York, N.Y. 01 Apr 2019: A.1.

“There is a large academic literature on whether market returns are predictable. The general conclusion is that it is impossible to predict the market return with any confidence… ‘A Comprehensive Look at the Empirical Performance of Equity Premium Prediction,’ by Amit Goyal and Ivo Welch (Review of Financial Studies, 2008), is a good summary of the evidence.”
Kenneth French, Roth Family Distinguished Professor of Finance
Tuck School of Business at Dartmouth College

Market Review

As you can see by the first 2 quotes above, the newspapers and so called “experts” are not really good at predicting the future, and investors should not rely on what they read in the newspapers for investing in the market.  The quotes also show how “sentiment” can change quickly in the press. Investors should heed the advice in the 3d quote above, as it is impossible to predict the future persistently and consistently.

Below are the indices we follow.

Obviously it was a very good quarter.  One of the best in several decades. The S&P 500 gained 13.65%, and the Russell 2000 (small cap) was up 14.58%. The leadership of growth stocks has come to the forefront so far in 2019 compared to value stocks. Growth stocks, as measured by the Russell 1000 Growth Index, advanced 2.85% for the month and 16.10% for the quarter, while value stocks, as measured by the Russell 1000 Value Index, gained 0.64% and 11.93%, respectively, in March and in Q1.

International equities started the year off strong as well, but their gains have not been as good as U.S. equity markets.  The MSCI World ex USA Index, a broad measure of international equities, gained 10.45% for the quarter, and Emerging Markets were up 9.92%.  Below are graphics of the MSCI All World Country Index for the last quarter and year. It gives a pretty good picture of how world equity markets have performed, with corresponding news headlines throughout the timeline.

However, it is important to note that since 1970, international stocks outperformed US stocks in the decades of the 70’s, 80’s, and 2000’s, or 3 of the last 5 decades.  There is a benefit to long-term diversification.

Below is a very good piece from our friends at Dimensional talking about long-term discipline in investing.  Too many people make bad decisions based upon the short term. Variability in returns is very high in the short term, as evidenced by the 4th quarter of last year compared to the 1st quarter of this year.  I feel sorry for Sierra Investment Management’s clients referenced in the very first quote at the beginning, whoever they may be. As evidenced by the quote from the Wall Street Journal on January 3, 2019, if their clients followed Sierra’s advice, they would have missed one of the best quarters in several decades.

Déjà Vu All Over Again
Dimensional Fund Advisors

Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities. Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.”

WHAT’S HOT BECOMES WHAT’S NOT

Looking back at some investment fads over recent decades can illustrate how often trendy investment themes come and go. In the early 1990s, attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan. A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or trends have come into and fallen out of vogue. In the 1950s, the “Nifty Fifty” were all the rage. In the 1960s, “go‑go” stocks and funds piqued investor interest. Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of information technology and telecommunication services. During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular. In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest rate environment in the following years, other funds sprang up that claimed to offer increased income generation, and new strategies like unconstrained bond funds proliferated. More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered attention among investors.

THE FUND GRAVEYARD

Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world.

With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.

It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured.1

WHAT AM I REALLY GETTING?

When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:

1. What is this strategy claiming to provide that is not already in my portfolio?
2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?
3. Am I comfortable with the range of potential outcomes?

If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, a market portfolio offers the benefit of exposure to thousands of companies doing business around the world and broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio, investors should understand the potential benefits and risks of doing so.

In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals.

CONCLUSION

Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets.
A Few Other Interesting Articles From the Last Quarter (Click on Links Below)

Analyst Forecasts – A Lesson in Futility

Investing for Retirement Isn’t Just About Money

Key Questions for Long-Term Investors

Until next time,

Mike and Emily

“The irresistible urge to seek patterns can get us into serious trouble when we take this tendency to the field of finance and investing. So, as investors, it’s important to know that we’re dealing with something where randomness and chance can distort the expected outcome in the short term.”
Vishal Khandelwal

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”
John Kenneth Galbraith

“The high volatility of stock returns is common knowledge, but many investors may not fully appreciate the implications of return volatility. Investors cannot draw strong inferences about expected returns from three, five, or even ten years of realized returns. Those who act on such noisy evidence should reconsider their approach.”
Eugene Fama and Kenneth French

Markets.

Equity markets around the world posted strong negative returns for the quarter and calendar year. Below are the indices we follow.

Although painful, such returns are not abnormal, as Fama and French allude to above.  The S&P 500 is negative almost 25% of the time in any given calendar year since 1926 as shown by the chart below.  Further, the standard deviation (a measure of how much actual returns have varied from the average) of the S&P 500 is almost twice as much as its long term average.

In addition, both value stocks and international stocks have underperformed recently.  We get questions on whether we should avoid such asset classes in favor of large US stocks.  However, as memories are indeed short, I would like to remind investors of the dismal performance that US stocks had from 2000-2009.  As our friends at Dimensional point out below, there are definite benefits to diversification, although it may not feel like it in the short term.

Dimensional Fund Advisors on Why Should You Diversify?

For the five-year period ending October 31, 2018, the S&P 500 Index had an annualized return of 11.34% while the MSCI World ex USA Index returned 1.86%, and the MSCI Emerging Markets Index returned 0.78%. As US stocks have outperformed international and emerging markets stocks over the last several years, some investors might be reconsidering the benefits of investing outside the US.

While there are many reasons why a US-based investor may prefer a degree of home bias in their equity allocation, using return differences over a relatively short period as the sole input into this decision may result in missing opportunities that the global markets offer. While international and emerging markets stocks have delivered disappointing returns relative to the US over the last few years, it is important to remember that:

• Non-US stocks help provide valuable diversification benefits.
• Recent performance is not a reliable indicator of future returns.

THERE’S A WORLD OF OPPORTUNITIES IN EQUITIES

The global equity market is large and represents a world of investment opportunities. As shown in Exhibit 1, nearly half of the investment opportunities in global equity markets lie outside the US. Non-US stocks, including developed and emerging markets, account for 48% of world market capitalization¹ and represent thousands of companies in countries all over the world. A portfolio investing solely within the US would not be exposed to the performance of those markets.

THE LOST DECADE

We can examine the potential opportunity cost associated with failing to diversify globally by reflecting on the period in global markets from 2000–2009. During this period, often called the “lost decade” by US investors, the S&P 500 Index recorded its worst ever 10-year performance with a total cumulative return of –9.1%. However, looking beyond US large cap equities, conditions were more favorable for global equity investors as most equity asset classes outside the US generated positive returns over the course of the decade. (See Exhibit 2.) Expanding beyond this period and looking at performance for each of the 11 decades starting in 1900 and ending in 2010, the US market outperformed the world market in five decades and underperformed in the other six.² This further reinforces why an investor pursuing the equity premium should consider a global allocation. By holding a globally diversified portfolio, investors are positioned to capture returns wherever they occur.

PICK A COUNTRY?

Are there systematic ways to identify which countries will outperform others in advance? Exhibit 3 illustrates the randomness in country equity market rankings (from highest to lowest) for 22 different developed market countries over the past 20 years. This graphic conveys how difficult it would be to execute a strategy that relies on picking the best country and the resulting importance of diversification.

In addition, concentrating a portfolio in any one country can expose investors to large variations in returns. The difference between the best- and worst‑performing countries can be significant. For example, since 1998, the average return of the best‑performing developed market country was approximately 44%, while the average return of the worst-performing country was approximately –16%. Diversification means an investor’s portfolio is unlikely to be the best or worst performing relative to any individual country, but diversification also provides a means to achieve a more consistent outcome and more importantly helps reduce and manage catastrophic losses that can be associated with investing in just a small number of stocks or a single country.

A DIVERSIFIED APPROACH

Over long periods of time, investors may benefit from consistent exposure in their portfolios to both US and non‑US equities. While both asset classes offer the potential to earn positive expected returns in the long run, they may perform quite differently over short periods. While the performance of different countries and asset classes will vary over time, there is no reliable evidence that this performance can be predicted in advance. An approach to equity investing that uses the global opportunity set available to investors can provide diversification benefits as well as potentially higher expected returns.

Exhibit 3. Equity Returns of Developed Markets

Investing is complex and can be scary. The best way to achieve long-term success is to:

• Create an investment plan to fit your needs and risk tolerance
• Structure a portfolio to capture dimensions of expected returns
• Diversify globally
• Manage expenses, turnover and taxes
• tay disciplined through market dips and swings.

We know day to day volatility of markets can cause anxiety. To get long-term returns, investors must endure both volatility and negative returns periodically. As you can see, it is definitely not a straight line.

Please call if you would like to set up a meeting to discuss your investments and plan.

Best,

Mike and Emily

Source: Dimensional Fund Advisors LP.

Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

1. The total market value of a company’s outstanding shares, computed as price times shares outstanding.
2. Source: Annual country index return data from the Dimson-Marsh-Staunton (DMS) Global Returns Data, provided by Morningstar, Inc

“Losses loom larger than corresponding gains.”
Amos Tversky

“People generally feel a stronger impulse to avoid losses than to acquire gains.”
Daniel Kahneman and Amos Tversky Read more

The endowment effect is a human bias that places a higher value on what one owns over what one does not own. Merely taking ownership of a stock, a bond, exchange-traded fund (ETF) or any other investment asset does not alter its economic value. The asset is only worth what the prevailing market price is. Yet, the endowment effect can cause us to be averse to selling the object by making us view the investment as being more valuable than it really is merely because we already own it. Read more

“A big challenge for an advisor is to help clients understand that this was a normal outcome and that, ‘No, we don’t need to adjust our portfolio because this quarter it went down. This was in the range of perfectly reasonable outcomes.”
Kenneth French
Professor of Finance, Dartmouth Read more

McCartney Wealth Management is excited to add to its traditional investment offerings a new program, Investing for a Better Tomorrow^SM.   Read more

“Since failures are buried and we don’t hear about them, investors are led to overestimate their chances of success.”
Nassim Taleb Read more

“People have a strong tendency to go along with the status quo or default option.”

“Unrealistic optimism is a pervasive feature of human life; it characterizes most people in most social categories. When they overestimate their personal immunity from harm, people may fail to take sensible preventive steps.” Read more

“Another example of a foundational value is I don’t believe in any short-term thinking or dealing. Let’s say I’m doing business with somebody and they think in a short-term manner with somebody else, then I don’t want to do business with that person anymore. I think all the benefits in life come from compound interest, whether in money or in relationships or love or health or activities or habits. I only want to be around people that I know I’m going to be around with for the rest of my life. I only want to work on things that I know have long-term payout.”
Naval Ravikant
Angel Investor Read more