Last week I had the opportunity to spend the day with Fidelity’s top investment research minds at its portfolio construction day. Today I’ll share six major myths presented at this session. This is an article heavy in details, proceed only if you’re interested a deep dive into the mechanics of portfolio design.
Truth: It sure does! This myth stems from the urge to rush into an investment because it looks favorable right now. But right now doesn’t necessarily mean right for you and your goals. Ask yourself how this investment is going to solve your financial goals 1 to 3 years, 5 to 10 years or 20 to 30 years from now. For instance, if you’re particularly sensitive to short term market dips, don’t take more risk than you can stand. Time is an asset and your overall best antidote to risk. Does your investment timeline line up with your goals?
Myth #2: Avoid Bonds When Rates Rise
Truth: It depends on how fast rates rise. When yields (rates) rise, bond prices fall and the performance on those bonds you currently hold fall with it. One source of protection for your bond holdings is known as the roll (turnover). Bond funds have a natural turnover based on maturity. Over time, older bonds fall out and get replaced by newer bonds. When rates rise, those new bonds come in at a higher rate, better for you. If rates rise too fast, your current bonds take a larger hit. If rates rise slowly, the new higher yielding bonds coming into your funds can sufficiently offset losses. In other words, it’s not all bad news. Do you know your bond sensitivity? We can do a sensitivity analysis for you on your holdings, just ask. What’s most important is to make sure you’re being compensated for the risk you’re taking. Try predicting the rate rise and you may run into a case of WTF!? (What The Forecast!?). Without fail, consensus economist rate forecasts for the last decade have been repeatedly off the mark.
Myth #3: Investments In Value or Growth Provide An Edge
Truth: Know your sector! Sectors provide far more predictable risk and return attributes than growth or value. Fidelity ascertains that too many of today’s investors have been taught to make decisions based on value and growth and the market has erased any edge that may have existed 10 to 20 years ago in those style areas. When too many people in the market do the same strategy, the benefits of that strategy tend to disappear. Instead, know your investments. The technology sector, for example, tends to be more volatile and have a higher potential return than the utilities sector. All things you or your asset manager should be aware of. If you see investments named value or growth, you may be at risk of an out of date portfolio!
Myth #4: Active Management Can’t Win
Truth: Fidelity says active management can win. The active versus passive debate is heated and ongoing. Fidelity, which sells actively managed funds, argues that if you’re going to pick an active manager, go for the large shops that bring a high level of combined expertise and where the expenses will be reasonable due to the economy of scale. Their data showed that active managers in large US equities can outperform over the last 20 years when you look only at the funds of the largest firms, Fidelity included. We don’t agree with this one. Their active wins result is likely heavily skewed towards the first part of the 20 years of the study when market competition was smaller, technology hadn’t invaded the markets and alpha was generally easier to come by. Today, it’s increasingly difficult to find sustainable alpha in large US equities and charge 1.00% for it, especially when Vanguard index investments like VTI (All US Equities ETF) cost only .05% (or 95% less). This may be an inconclusive myth for the time being but we believe the future favors the indexers.
Myth #5: General International Exposure Is Sufficient
Truth: Know your international investments! Fidelity’s argument here is similar to myth number 3. They warn that picking an international fund and calling it a day may leave you with an undesirable result. Non US equity is too large a category with too many pieces to lump together in one allocation decision. Do your research and know what you’re owning. Ask your investment advisor to explain what you own and why you own it, and make sure you’re being compensated for every unit of risk you’re taking. Also, you can forget trying to predict currency directions. The currency forecasters are even worse than the rate forecasters. Their forecast results look like the dartboard in your garage.
Myth #6: Choose the single best investments
Truth: Choose the best investment portfolio. Aim to build the best possible portfolio for your goals rather than amass an assortment of your best investment ideas. In other words, make sure the team, your investments, are working together towards a common goal and not running off in their own directions. Think Olympic basketball, when the best of the best US players end up losing to an international team with inferior players that played better together. “Pick your best eleven, not the eleven best.”
Max Osbon – firstname.lastname@example.org
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