Ross False Hope of Global Diversification

Confessions of a Portfolio Management Maverick
1. Auflage 2022
ISBN: 978-1-5445-3212-7
Verlag: BookBaby
Format: EPUB
Kopierschutz: Adobe DRM (»Systemvoraussetzungen)

E-Book, Englisch, 136 Seiten

Most financial advisors and planners have known since the 1990s that global diversification of client investments using funds and EFTs is an outdated technique. The system just doesn't perform well. So why are we still doing it? In The False Hope of Global Diversification, Wall Street and portfolio management veteran Michael Ross explains why it doesn't perform well-laying out step by step what financial advisors should be doing instead to protect their clients' assets. Learn how to grow your clients' wealth using a diversified portfolio of primarily US-based companies and US company bonds. Improve portfolio performance, reduce costs, and raise client satisfaction to new heights. Along the way, Ross offers pragmatic, real-world examples for presenting the system to clients in ways they will understand and appreciate (and even be excited about)-boosting client confidence through good markets and bad for their long-term success.

Autoren/Hrsg.

Ross, Michael

Leseproben

Chapter One
I Know Your World
As I said in the Introduction, I have been a financial advisor since 1987. I saw the Dow Jones Industrial Average fell 22.6 percent in a single day. This decrease remains the index’s largest single-day drop on record. What isn’t mentioned often in this statement is that the Dow recovered to a positive annual return by year’s end. During the three-plus decades since, I have witnessed six “bear markets” (when the market drops over 30 percent in one short period). During each of these crises, I have had progressively fewer clients panic. If memory serves me correctly, no client bailed out of the market in 2020. My goal is to give you techniques allowing similar outcomes with your clients. During my entire career, I have been a bit of a continuing education junkie, getting a handful of advanced credentials that have formed my opinions about how to manage clients’ money. In the following pages, I will share what I have learned with you. I invite you to spend a weekend reading the book. Please write in the margins, highlight as you wish, and provide me with any feedback that you feel led to give me. I’ll begin with a few observations. The limits to Modern Portfolio Theory Dr. Harry Markowitz earned a Nobel Prize for describing how you can diversify your assets to achieve lower risk while getting higher returns using a variety of assets with different performance cycles. The mathematical language describing this performance cycle diversity is correlation and covariance, and any finance professional must acknowledge that these issues matter. In basic parlance, this means that the investor should spread their assets across multiple asset classes, especially those whose performance cycles vary: when one zigs, the other one zags. This does, in fact, smooth our year-over-year performance. It is important for financial planning. It is never perfect, but it does tend to make future asset growth rates more predictable.1 Now, stop right there. In the modern world, this concept is taken much, much too far. We want investments that zig and zag considerably from one another, not slightly, but close to 100 percent. Stocks and bonds. Bonds and real estate. Cash and venture capital. You get the idea. Using Modern Portfolio Theory to justify investing in only slightly non-correlating assets is a waste of time and money. The most important example of this is the correlation between the Standard and Poors’ 500, better known as the S&P500, and the Europe, Asia, and Far East Index, better known as the EAFE index. We both know that for your entire career and mine, the traditional financial planning community has pushed you to have international diversification, yet that all-import metric, colloquially described as “when one zigs the other zags,” or correlation shows that this is false diversification. When one asset’s performance is completely countercyclical to another’s, it is said to have a correlation of -1. Naturally, when the correlation is tight, the correlation is +1. The correlation between the S&P500 and the EAFE index has risen to almost +1 in the last twenty-five years. Note the following. These are time series of correlations between the Standard and Poor’s’ 500 and the EAFE (Europe, Asia and Far East Index) of mature, publicly traded companies. These are market capitalization-weighted indices. The “Y” axis is correlation, so when the correlation is “1,” these markets are moving in lockstep with each other. Note in the 10-year data set that this really began occurring in the late 1990s into the 2000s. While there is clearly disassociation in the five-year correlations, it almost vanishes in the 10-year data series. Since most advisors tell their clients “you can’t time the market” and “we are in this for the long run,” why invest anywhere but the United States? You take multiple risks out of the equation and get the same, if not better, performance. Data in this series is from Bloomberg; charts courtesy of Max Grossman. So with very few exceptions, there has been an incredibly tight correlation between the S&P500 and the EAFE index. But wait, there’s more As we will cover later, incredulously, China remains considered an “Emerging Market.” I know. How is the second-largest economy in the world considered emerging? Can’t make this stuff up, folks. We did the same comparisons between the S&P500 and the Morgan Stanley Capital International (MSCI) Emerging Market index. As you might imagine, the Emerging Market Index is heavily weighted toward China. While this one is clearly much more volatile and not as nearly clear cut, the central tendency provides a meaningfully high correlation again. Noisier than the comparison between the US and mature international markets, This time series of correlations between the Standard and Poor’s 500 and the MSCI Emerging Markets index. (Can you believe China, the second largest economy in the world is considered an “Emerging Market?”). Like the previous data sets, these are market capitalization-weighted indices. The “Y” axis is correlation, so when the correlation is “1,” these markets are moving in lockstep with each other. While there is clearly disassociation in the five-year correlations, it almost vanishes in the 10-year data series. While the S&P 500 tightened correlations in the mid 1990s, the Emerging markets tightened in the late 2000s. Since most advisors tell their clients “you can’t time the market” and “we are in this for the long run,” why invest anywhere but the United States? You take multiple risks out of the equation and get the same, if not better performance. Data in this series is from Bloomberg; charts courtesy of Max Grossman. The conclusion we must draw from these sets of data is that mathematically, as well as logically, the march toward globalization renders all the global stock markets in sync with one another. Consequentially one really cannot reduce the risk of the equity portion of their portfolio with diversification between different countries or regions. Which begs the question: why should an American investor “diversify abroad”? Also, one must dig into the data to see if this very tight correlation happens all the time. My best examples are the real stock market crises of my career: the 1987 crash, 9/11, and the Global Financial Crisis, to name the most significant. Look closely at all the asset class performance and also just think about it. You will notice and realize intuitively that it was always about liquidity. When—due to investor confidence—there is plenty of supply and demand for stocks or bonds, we all profit. When, really for whatever reason, liquidity vanishes, markets crash. Globally, all markets crash at the same time. Further, and even more important: all these only minutely non-correlating assets’ (like international stocks and small cap growth stocks) movement correlated very tightly during these liquidity crises. This is why markets went down! During those time frames, you received absolutely no benefit from this minuscule number of non-correlations. It just wasn’t worth either the effort or the cost of diversification. The above charts take data noted in the previous correlation charts and focus on specific “Bear Market” time periods. Again, the correlations are between the Standard and Poor’s’ 500 and the MSCI EAFE Index. Note that during these periods of extreme market duress, the two indices trade in lockstep, with correlations very, very close to 1. Data courtesy of Bloomberg; charts developed by Max Grossman. The sheer tragedies of my career were clients who bailed at the bottom of the market because they were scared. They saw their market values go down and quickly turned to some news source. The news source predictably was preaching doom and gloom. They deduced that things were only going to get worse, so they called and sold everything. How did this happen when they were “well-diversified”? It happened because, in times of crisis, liquidity dries up, and every kind of stock goes down. I have learned in thirty-five years that asset allocation is stocks, bonds, cash, and real estate. Don’t use varieties of stock. Consider all those stock asset classes Russell and Associates dreamt up to be one asset class: stock. If you are an accredited investor (more about this later), there should be both public and private equity. Public and private each have risks and rewards, but they are often noncorrelating. This is where you get the diversity bonus; you don’t get that diversity bonus by having large cap growth and small cap value, international stock, and emerging market bonds. Second, own individual stocks with household names. Again, you cannot do this completely because different households have different names, but you can get close. Here’s where psychology plays in. If it feels like everything is bad, you might want to sell the market. But will you honestly lose confidence in those companies from whom you buy things? Whether it’s Microsoft, Proctor and Gamble, Apple or Costco Wholesale, those companies give you a good feeling which often transcends your crisis mentality about “the market.” You relax; you don’t panic. Quick, what is the most expensive part of investing? You say “commissions” or “loads” or “fees,” right? Wrong. Way off. The most expensive part of investing is paying taxes. Worse, they are a silent killer. Volumes of books have been written about investing. More...