Your Strategy Will Sometimes Lag And That’s OK
By Roger Nusbaum, AdvisorShares ETF Strategist
Barron’s featured an ETF Roundtable that focused on smart beta funds. The actual discussion wasn’t all that interesting but there was an important general point made about investment strategies.
Gray: Value investing is driven in part by behavioral biases—otherwise, why wouldn’t everyone just be Warren Buffett and buy cheap stocks and hold them? They don’t because if you hold concentrated, cheap-stock portfolios, there will be multiple years when you’ll get your face ripped off. You need clients that understand how true active strategies work over the long term.
Indeed, the cheapest U.S. stocks have trailed more expensive growth stocks for nine years now.
Whistler: The challenge with strategic beta, or any factor-based investment, is that they can underperform a traditional cap-weighted index for quite a long period—two, three, even five years.
For purposes of this blog post, value investing is merely an example, there are plenty of valid strategies that could replace value in the excerpt.
The passage is important because it accepts as an inevitability that any given strategy will have periods where it lags. Value has lagged for the entire bull market until this year, according to another Barron’s article from this weekend, but there is no sentiment that somehow value is not a valid investment strategy. Value or growth, buy and hold no matter what, indexing or passive and on and on are all capable of getting the job done.
Underperformance for a couple of years although completely normal potentially breeds impatience which can lead to chasing the performance of what just did well in the expectation that it will continue to do well. In simplistic terms something that just outperformed last year has a good chance of underperforming this year. The person who perpetually chases last year’s winner has a high likelihood of always lagging which does not have to be ruinous but does make things harder over the long term in terms of keeping pace with the projection of “the number.”
My preference is to maintain exposure to various market segments; small cap/large cap, growth/value, foreign/domestic, high dividend/no or low dividend and so on. And like any approach out there, there are times where my preference outperforms and times where it lags.
More important than returns are savings rates and the avoidance of self-destructive investment behaviors.
At a high level everyone knows they need to save money but doing it is the hard part. People who save 10%, 15% or more are making things easier for their future selves and are acting on the thing they have far more control over; saving money versus the whims of the capital markets. Chasing previous top performers is just one of countless behavioral things that people do to themselves.
My hope in revisiting these building blocks, especially when others in the field say essentially the same thing, is that hopefully more market participants will come to realize that how they are doing in 2016 simply won’t matter in the long run. As I often mention in this context, “without looking, how’d you do in the first quarter of 2012?” The only way someone is likely to know is if something catastrophic happened to their portfolio.