May Market Update and Why You Need Active Investment Management
Photo courtesy of Patrick McGarvey / Flickr
Markets are up 17.5 percent year-to-date! That's a lot for a four month investment return, right? Perhaps not when we consider that the S&P 500 is basically back to zero from the fourth quarter correction. While you are probably happier looking at your April 30 investment statements, it would be wise to reconsider taking these large round trips in the future and instead minimize future hits to your portfolio.
Yes, the investment markets have become obsessed with passive management and their very inexpensive management fees. Passively managed assets are expected to double from
2016 to 2025 from $14 trillion to $37 trillion. They are typically bought in the form of index funds or ETFs (Exchange Traded Funds). However, while passive management is cheaper in fees, it can be expensive in terms of its opportunity costs to your portfolio.
Here are five things to consider if you want to minimize damage to your portfolio:
Active management can improve stock returns. When the markets corrected during the fourth quarter of last year, valuations in the form of ratios for several sectors were getting very expensive (i.e. price-to-earnings and price-to-cash flows). However, there were still sectors that were still relatively cheap. The sale of some expensive assets would have decreased losses. You wouldn't buy a house that was priced above the comps in its neighborhood—why do that with investments?
The pace of global growth as compared to the grow rates assumed by the prices of the stock markets and individual company prices. For example, the current P/E for the S&P 500 is approximately 17 percent or right around its 25 year average for the domestic market. However, while the U.S. GDP was 3.2 percent year-over-year in the first quarter of 2019, it is expected to slow down significantly to 2-1.5 percent by the end of the 2019 and the foreseeable future. In other words, domestic P/Es remain high as the U.S's expected growth rate is declining. Are there cheaper investments in other parts of the world?
Active management of your bonds is important as well. Why is this the case? The level of interest rates not only affects the income that your bond portfolio produces, but they also determine if the bonds' value could decline while you own them. When interest rates increase, the value of your bonds decrease, and the longer the maturity of your bonds, the more they decease is value. Right now, no one knows what the Federal Reserve will do with future interest rates. (The Fed probably doesn't even know!) One of the prudent things you can do is to decrease the maturities of your bonds. Another area of scrutiny includes how capable the companies that issued these bonds are of making their interest and principal payments (i.e. credit risk).
Investor sentiment can continue to push up asset values even when markets are expensive. Watch this closely, as well as where money flows are going—or not going. You cannot fight "the tape" or direction of the markets, but you can take advantage of them. For example, is there a large exodus in U.S. technology stocks? Then maybe it's time to trim. Are monies going into cash or short-term bonds? Then look at how heavy you are with bonds that mature several years from now.
The world of investments is not restricted to the public markets. There is a very large world of investments on the private sides of equities, debt, real estate and other investments. These types of investments are being purchased more: pensions and university endowments. The reasons for the increase include: lower volatility, increased expected returns and lower correlation to the public markets. If your portfolio is of a certain size, these investments may be an good option.
If your investment portfolio is to meet your long-term goals, it's critical to minimize the amount of the drawdowns it experiences during market corrections. The performance needed to make up a period of market underperformance significantly increases as losses become greater. For example, a period with return of -20 percent would require a positive return of 25 percent to recover, while a period with a return of -50 percent would require a return of 100 percent! Keep in mind that the last two market corrections were -49 percent and -51 percent respectively (during the early 2000s and the Great Recession). The summary you should take away from this is as follows: avoiding losses is more important to your long-term investment performance than posting gainings.
Knowing this information, you now have two choices. One, ride the market's waves of the investment markets understanding that you may have less money than you anticipated in the future, as well as a lower standard of living. Two, have your assets actively managed in respect to the underlying valuations and sentiment. Please understand this: If your investment advisor is being passive with your investments, then you are being passive with your future. Is this a risk you are willing to take?
About the Author
Michelle Connell, CFA is the President and Owner of Portia Capital Management, LLC., the only registered investment management firm in the Dallas/Fort Worth area owned by a female Chartered Financial Analyst (CFA). The CFA designation is considered the highest designation in the investment management profession, and fewer than three percent of all CFAs in Texas are women. Ms. Connell is also one of highest-rated finance professors in the United States, currently serving as an adjunct professor at The University of Texas and instructing CFA candidates through the CFA DFW Society. For her clients — including the underserved markets charities, foundations and high-net worth women — Ms. Connell crafts personalized solutions that include conventional products as well as rare access to alternative assets, including private equity, private debt and real estate, and allows investment portfolio creation with greater downside protection and more consistent returns. Through her philanthropic initiative, “Portia’s Children,” 10 percent of the firm’s profits are donated to charities working to improve the lives of children of single-parent homes.