When we review prospective client portfolios, it is almost guaranteed some portion of their money is invested in some sort of active management strategy. As you may know, active management is the strategy of attempting to beat a benchmark. This could be done through market timing (buying and selling at opportune times) or stock picking (buying winning stocks and selling ones that will underperform). The alternative strategy is often called passive management, though we like to call it "evidenced based" management. Essentially, you own the entire market and don't try to time when to buy or sell securities or pick one stock over another. The "evidence" suggests that this method of investing has a much higher probability of success.
As I was thinking about the idea of probabilities, I thought it might be fun to compare active management to another game that is all about probabilities…blackjack. First, let's look at the statistics on active management. Actual results* show us that 17% of stock mutual funds have beaten their benchmark over the last 15 years. Bond funds fared much worse, with only 7% beating their benchmark during the same period. If the goal of active management is to beat a benchmark, they are not doing a very good job.
So what about blackjack? The odds you will win one hand of blackjack (factoring out ties) is 46.36%. But we are measuring 15 years of whether an active manager can beat the benchmark. What is the chance you will win money at blackjack if you play 15 hands in a row? The answer: 17.5%.
Long story short- you have almost identical odds to walk away with more money after 15 hands of blackjack than you do trying to pick an active manager that will beat the market over 15 years. The odds are much worse trying to pick a bond fund that will beat the market. We all have heard that as long as you play for a long enough time, the house always wins. Maybe you should think about who the "House" is when you are investing and shift the odds more in your favor.
*The US Mutual Fund Landscape, 2016 Report
If you were thinking "What is Brazil?" you could claim victory over your opponents who might have scribbled down, "What is the U.S.?"
That might leave the audience scratching their heads as they recall some pretty negative news that came out of Brazil last year. Zika…Dilma Rousseff’s impeachment….favelas….deforestation….green swimming pools at the Olympics. Brazil had a tough year in many ways but its benchmark index was up over 65%.
What might be even more surprising is that the top 10 stock indexes in 2016 were all emerging or frontier markets. The MSCI Emerging Markets Index as a whole was up over 11% in 2016.
You might say 2016 was a crazy year and this could be just one more example of that. Actually, nine of the 10 best performing equity indexes over the past 20 years have been in developing nations. Before you bet the farm on Emerging Markets, you need to flip the coin and look at all the 2016 data. The markets with the worst losses were also dominated by emerging markets.
If some emerging markets can do really, really well but some can also do pretty badly, do they have a place in the portfolio? Greenspring thinks so.
We believe in a globally diversified portfolio that has exposure to US, Developed and Emerging Markets. Your individual risk profile then helps us structure how much of your portfolio each of these equity components should comprise.
Final Jeopardy Question: What is "the only free lunch in investing"*?
Answer: "What is diversification?"
*Harry Markowitz, founder Modern Portfolio Theory
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.