Reconciling Disappointing Short Term Performance vs. Achieving Long Term Goals

 As I have shared with most of you, managing your portfolios the past 2½ years has been challenging, difficult, and, at times, excruciating. The balancing act of mitigating risk as well as generating reasonable risk adjusted returns is analogous to walking a tight rope. The vast majority of my clients have experienced little or no gains in their accounts over this time frame. Many of you have expressed your concern and frustration over these results. In fact, some of you are wondering whether your portfolios will be able to successfully generate the long term returns required to meet your financial objectives. The purpose of this newsletter is to discuss the challenges of the current investment environment and my focus on assisting you to achieve your investment and retirement goals.

For obvious reasons, the starting point for this discussion is the performance of US equities. Most investors compare the returns of their accounts to the Dow Jones Industrial Average or S&P 500 because these indices are ubiquitously reported in the media. Since the nadir of the stock market on March 9, 2009 to the present, the S&P 500 has averaged approximately 17% annually. But the stock market is not the appropriate barometer to compare returns since I apply an asset allocation model that includes a broad spectrum of asset classes. Over the past several years, most asset classes including foreign equities, commodities and emerging markets, have experienced mediocre if not dismal returns. As I constantly remind clients, the objective of an asset allocation model is diversification among all asset classes and to avoid concentrated positions in a category that may appear to be more promising than others. When I form a strong conviction on the upside potential of a particular asset class, diversification must be maintained to buffer the impact that a negative surprise will have on portfolio returns. Perhaps the question that disgruntled investors might ask themselves is how a conversation with their advisor might differ if the stock market had continued its descent from 2008 to the present and their portfolio has been heavily skewed in equities. As a reminder, the investment goal of asset allocation is to generate consistent less risky long term returns. The measure of performance is aligned with the long term financial goals of the client and not based on stock market performance.

Years ago, Aaron Levenstein, a highly respected business school professor, made an insightful analogy. "Statistics are like a bikini. What they reveal is suggestive, but what they conceal is vital." Over the past year, due to inquiries from concerned clients, I have conducted analyses of my moderate growth portfolio returns pre and post 2008. Due to the 35-40% decline most accounts experienced in 2008, many of my portfolios

have only marginally recovered since drops of this magnitude require gains of almost 70% just to regain the loss. But when I measure performance from the market low on March 9, 2009, the average annual return of my portfolios range between 9-10%. As is abundantly clear, returns will widely vary depending on the time frame chosen particularly in very volatile markets.

 An added ingredient to this mix of angst and frustration is the clear out-performance of low cost equity index funds and exchange traded funds (ETFs) vs. actively managed funds from the market low through 2014. As the old adage goes, "a rising tide lifts all boats", so went the stock market. Almost without exception, all sectors in the stock market rallied with little regard of the investment merits of individual companies. Many articles in the financial press extolled the virtues of low cost higher performing ETFs and index funds vs. actively managed funds. Due to this hype, many investors began to believe that allocating their portfolios to a small group of index funds would result in lower costs and higher returns, the best of all worlds.

But in the investment world as in other aspects of life, there is mean regression. In this case, index funds climbed to the top of the mountain until 2015 when the bull market began to run out of steam. In this type of environment when security selection becomes paramount to out- performance, returns of many highly rated actively managed funds began to shine. While we cannot be certain this trend will continue, history suggests that this is the most likely outcome. One of my roles is to identify and invest with those portfolio managers who have established excellent long term track records where investors have the opportunity to generate returns in excess of market benchmarks.

Between dismal returns and the constant beat by the media of lower cost high performing index funds, many investors continue to question the value of asset allocation. My mandate for you is to produce consistent long term returns that improves the chance that you don't outlive your money. Despite the challenges of the past 2½ years, I remain convinced that an asset allocation formula with the dual objective of reducing risk and delivering consistent long term returns is the correct path for the vast majority of my clients and I will continue to work hard to help you achieve this objective.


Clifford L. Caplan, CFP® , AIF®


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