Monday, July 29, 2013

How Quickly We Forget

Barry Ritholtz of the blog The Big Picture wrote a good editorial for the Washington Post which appeared in yesterday's paper.

Ritholtz points out that it was only a few years ago that the press was full of quotes from pundits proclaiming that cataclysmic events were just around the corner.

Whether it was the general hand-wringing over the political morass in Washington, or decrying the overall state of affairs in American society, it was taken almost as a given that the only safe place for investors was either in gold or ultra-safe Treasury bills.

Problem is, this advice turned out to be terrible, and cost investors and savers the chance to invest in high quality stocks at historically cheap prices.

Now, to be sure, some of these gloomier forecasts may yet play out, but one cannot help but be struck by the total lack of any sense of humbleness by these same sages.

Here's an excerpt from what Ritholtz wrote:

How many people have been calling for a market crash now for several quarters if not years? Cullen Roche of Pragmatic Capital describes what may be the biggest narrative failure: the Fear Trade.

“If you’ve been paying attention over the last few years, you probably remember how many people predicted hyperinflation, surging bond yields, soaring gold prices, a cratering U.S. dollar and a collapsing stock market. This was the fear trade. You overweight gold, short U.S. government bonds, short the USD, short equities and laugh all the way to the bank. On the whole, that trade has been a big disaster. In other words, fear lost out — again.”

He is right: None of those things has come to pass. Even worse, the fear traders have missed a 150 percent rally to all-time highs in the U.S. stock markets. While sell-offs are painful, over the long haul they tend to be temporary. The mathematics of asset class mean reversion is inescapable. Stocks will eventually recover, but if you fail to participate in a generational rally of this magnitude, it can set back your retirement by as much as seven years.

In the institutional investor world - home of the so-called "smart money" - it was an article of faith that a large chunk of an pension or endowment portfolio should be invested in hedge funds.

Lead by industry leaders such as David Swensen of Yale, the most common argument over the past decade was that the kind of buy-and-hold investing strategy was an old-fashioned concept.  Instead, investing with hedge fund managers whose investment acumen would shelter portfolios from volatility while earning out-sized gains was that only place for cutting edge investors.

So how has it worked out?

Today's Financial Times has an report which offers some clues.  Here's an excerpt from a front page article:

Since January 2010 the average equity hedge fund has produced profits for its investors, after fees, of just 14.5 per cent, according to the research group HFR. Over the same period  an investor in the S&P 500 earned, with dividends, a 55 per cent return.  Some 85 per cent of equity hedge funds are failing to match the market.

Now, to be sure, the past few years have been difficult for all active managers, and a large majority of the traditional managers have also lagged the S&P 500.  However, the magnitude of the shortfalls is not anywhere close to the hedge fund gaps, as the FT writes:

From the start of 2010 to the end of June this year, mutual fund managers have a higher investor return of 44.5 per cent, according to the research group Lipper.  Even though 83 per cent of mutual fund managers did not beat the S&P 500, few have failed the grade than among hedge funds.

There will always be a sense that somewhere, somehow, there is a "magic bullet" that will lead to investment success.

However, as Vanguard founder John Bogle is fond of saying, "Time is your friend, impulse is your enemy".

The large gains in investing have largely come from buying quality stocks and holding them for a very long time.  Not very "sexy", but historically this has proven to be the best strategy.