Flipping a coin is a truly random event. A coin will land on either heads or tails, and guessing right is a 50-50 proposition. The performance of actively-managed mutual funds is not as predictable. Funds that perform in the top half of their peer group during a five-year period had a less than 50% chance of staying in the top half during the next five-year period, according to a recent S&P Dow Jones study. Investors have better odds flipping a coin than using past performance to pick winning managers.
David M. Blitzer is managing director and chairman of the S&P Dow Jones Index Committee. He has the overall responsibility for index security selection as well as index analysis and management. A graduate of Cornell University with a B.S. in engineering, Dr. Blitzer received his M.A. in economics from the George Washington University and his Ph.D. in economics from Columbia University.
Wall Street is always coming up with cunning new marketing techniques to attract tourist investors. These are less-sophisticated individual investors and advisers who are easily wowed by glitzy industry trends, only to abandon them when the strategy falls short of expectations. The latest spin to attract tourist money is “smart beta.” The phrase didn’t exist one year ago, yet a Google search today shows 190,000 results. The inference that investing this way is smart has ignited a strong interest among less-sophisticated investors while those who truly understand what’s behind these strategies find the phrase distasteful at best.
I am a phenomenal index fund investor because my diversified U.S. stock index fund is taking the S&P 500 index funds to the cleaners. My fund is beating the Vanguard S&P 500 Index Fund (VFIAX) by 1.0% year-to-date through November 30, and it’s up by more than 1.4% over the trailing one-year period. This isn’t […….]
Foreign Stocks for the Long Run
Nearly every financial adviser will tell you that foreign stocks should be part of a well-diversified portfolio. Yet, an analysis of the data shows that non-US (foreign) stocks as an asset class have underperformed the US market by a meaningful amount for more than 40 years, in addition to having higher risk. So, why do it?
Last summer emerging markets, both stocks and bonds, had the distinction of being the most unloved asset class. Since then, markets have calmed down. Emerging market stocks are up around 9% since last summer, and have narrowly outperformed their developed market counterparts. Has the luster returned for EM? As is often the case with EM, the story is nuanced. Here are four things to keep in mind:
1) Headwinds remain. These include slowing growth in China and India, inflation in Turkey and India, and the looming uncertainty of how these markets will perform once the Fed finally begins to taper.
2) Be prepared for volatility. Despite the outperformance, as my colleague Dodd Kittsley notes, EM countries are still struggling with outflows. This is not surprising as this asset class remains highly volatile. EM stocks are still more volatile than DM and add considerable risk to a portfolio. Volatility is down from the summer, but remains elevated relative to developed markets. For example, the 3-month trailing volatility on the iShares Emerging Market ETF (EEM) is 19%, compared to 9-10% for developed markets. Practically, this means that any overweight needs to be constrained in all but the most aggressive portfolios.
3) Pay attention to corporate governance. Specifically, investors should remain cognizant of how EM companies are deploying their cash-flow. One of the key criticisms on EM companies is that while the economies may grow faster, probably much faster, economic growth has not always translated into shareholder value. This is because too many EM companies burn through cash flow. If investors are to make money in emerging markets, they need to be sure that economic growth eventually translates into corporate profits and free cash flow
4) Invest for the long term. Despite the caveats above, EM equities do represent a long-term opportunity for more aggressive investors. The main argument in favor of emerging markets – relative valuation – still holds, despite the outperformance. EM stocks trade at a significant discount based on both price-to-book (25%) and price-to-earnings (35%). At least historically, discounts of this magnitude have been associated with positive relative performance over the next year or longer.
In addition, while we don’t expect a boom in any of the larger EM economies, we do expect stability in 2014. And there are at least some positive catalysts on the horizon. Most notably, following a lukewarm initial reaction, investors are now starting to warm to the fact that China appears serious about reforming its economy.
In terms of specifics, we continue to see opportunities in Chinese equities. Despite the recent rally, valuations remain low and growth, while slower, is still better than any other large country. As I’ve advocated before, broaden the definition of EM to include a small allocation to frontier markets. Despite the travails of EM, the frontier markets are up over 20% year to date.
Finally, investors may also want to consider domestic companies levered to China and the rest of Asia, where spending continues to grow. One recent example, in the last quarter Tiffany reported a 27% jump in Asia-Pacific sales.
Today’s higher than average market valuation shouldn’t preclude you from putting new money into stocks. History shows that if you buy at today’s valuation and hold for the long-term that you will be amply rewarded. One way to look at the results is by measuring the market’s return using a same P/E to same P/E time horizon.
The debate between index fund investing and active fund investing is decades old. It really isn’t much of a debate, if you ask me. Historical data from Vanguard and S& P Dow Jones Indices shows that index funds have outperformed actively managed funds in every investment category over the long-term. But there’s another measure that isn’t discussed as frequently. It’s the payout.