By nature, I am an introvert. It is much more comfortable for me to listen than to talk. Recently, however, I came to the realization that this is not always the best choice. As a financial planner, my job is to be a good listener so that I can truly understand my clients’ thoughts, needs and concerns. Being a good listener is a critical component to offering the best advice to clients. If I don’t understand them, how can I advise them?
This week, however, I had an interaction with several clients that challenged me out of my comfort zone. They challenged me from not just being a good listener and giving good advice to realizing that I also need to be a good teacher.
Due to recent market events, I have naturally had clients ask questions about their portfolio performance. I have known this before, but this time it really hit me. I need to do a better job of talking and explaining and teaching on not just how we invest, but why we invest the way we do and the reasoning behind it.
I am planning to do a series of newsletters with this goal in mind. I am beginning today on the importance of diversification.
Despite the media’s relentless pursuit of scaring investors out of their wits all year, the headlines screamed what a great year it has been “in the markets.” They neglected to mention the wild ride that started in September that made investors feel like the markets were out to get them.
Over the years I have heard several people who were either not born American, or who had lived overseas mention how the American media all but ignores events in the rest of the world, unless it is something huge and horrible that happens. This appears to be the case with the reports on “the markets.” The reality is that the value of all publicly traded US stocks is usually between 45-49% of the total value of the world’s publicly traded stocks.
As someone recently pointed out to me, this is down dramatically from where it was in recent history – he can recall when the value of combined US public companies was 70% of worldwide public companies. I mention this, not to imply that US Corporations are declining in importance. Far from it. What I am illustrating is that there is a lot of intellectual capital and resource employment that happens outside our borders.
For this reason, we build globally diversified portfolios. What on earth does that mean? It means that we buy mutual funds that hold stocks that are based in countries all over the investable world. Although we see many headlines about Greece being in trouble, what about the successful German companies? Wouldn’t we want to employ our capital to benefit from what they are doing to grow the value of their companies?
Where this can become confounding to investors is when “the markets” have positive performance, but, as we have seen in 2014, the rest of the world experienced negative performance.
So, since we are more comfortable with American companies, why don’t we just own US Funds? The answer: Because there will be other years where the performance will be the opposite of what we saw in 2014. The US Markets will be down, international markets will be up.
This phenomenon actually has a name: non-correlation.
Professional investors actually seek out non-correlated assets, or assets that do not always move up and down at the same time. This cannot be achieved perfectly, as we well saw in 2008 when every stock market in the world was down, and down big. But for the lion’s share of the time, there is some pull of one market or asset class against another. Let’s relive one asset class’ history in the earlier part of this century.
In 2001 International Large Cap Value stocks were down 15.4%, one of the very worst performers of that year. After that year we would have had a conversation about why it is important to keep the mutual fund that represented that asset class, and you may have been tentative in your agreement.
So, we hope for better things for International Large Cap Value stocks in 2002. Well, things didn’t work out so well that year either, when they were down 13.8%. Now, you would have likely been questioning my reasoning and perhaps suggesting it is time to dump that loser.
Although you may have been ready to cut and run, we hang on for another year. Our human brains would be signaling some anxiety at this point, so hanging on would probably make you nervous. Guess what happened in 2003? International Large Cap Value was up 69.2%! It was also up 30.6% in 2004, 15.1% in 2005, 33% in 2006, and 6.3% in 2007. In the 2008 the asset class again took another tumble, but regained a lot of its ground in 2008.
To make the numbers more clearly discernable, see the columns below:
Performance on International Large Cap Value 1
If you had invested $10,000 at the beginning of 2001, at the end of the nine year period your investment would be worth $21,393, an 8.81% annualized return. That is pretty incredible given the extreme volatility the portfolio asset class experienced.
The point is that markets cycle in and out, and when these cycles are going to shift is completely unpredictable, despite what all of the pundits will try to have you believe.
Warren Buffett is quoted as saying, “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” 2
What history has shown us time and time again, though, is that after building a portfolio that captures the intellectual and material resources of corporations all over the world, sticking to that portfolio, with careful rebalancing will offer an investor the greatest chance of achieving their long term goals.
A non-investment analogy of the way a diversified portfolio works would be the equivalent of Small Ball in baseball. Your investments will be more successful in the long-term if you move the players forward a bit at a time through a series of singles and doubles rather than always trying for the home run and consequently striking out more often.
In summary, we are our clients’ Fiduciaries, and we take that responsibility seriously. We recommend not what feels right based on market noise and emotions, but what we know to be right. This is what we believe, this is how we invest our own resources and this is what we do for our clients.
1International Value Data provided by Fama/French from Bloomberg and MSCI securities data
2 Warren Buffett, Letter from Warren E. Buffet to the shareholders of Berkshire Hathaway Inc. Berkshire Hathaway Inc., Shareholder Letters (1980)