We talk a lot about our investment philosophy and process being evidence-based. What that means is that we spend a good deal of time researching and partnering with firms that help us understand and implement some of the most practical academic and industry research we feel will directly benefit our clients. That evidence has driven us away from many of the traditional approaches to investing like stock picking and market timing.
With our philosophy, we must be open to new research studies and real-life events to see if they support or challenge our approach. One recent study and some recent stock market behavior have provided some very confirming information.
We’ll start with the recent stock market behavior. Anyone that reviewed their fourth quarter statement would know that global stocks declined quite quickly in the last part of 2018. Our natural reaction to market declines is to get out and seek safety. Yet, we tell our clients time and again that we can’t predict markets—no one can—and that the best approach is to diversify and only hold as much stock exposure as we are willing and able to take.
That advice of staying invested and diversifying paid off. Global stocks surged in the first quarter and are almost back to their record high levels. Imagine if we gave in to our desire to flee the market when stocks fell? We would have missed out on the robust return in the first quarter. While it is certainly not a guarantee that the market will recover following a decline, that has been the historical pattern. Stock returns feel like they come in fits and starts, so we need to be invested during the times of growth to receive the return benefits stocks can provide.
Turning our attention to the recently released 2018 Standard & Poor’s Index Versus Active report, we find very strong evidence that stock-picking active managers continue to struggle versus their benchmarks. In 2018, only 36% of U.S. large cap managers, 32% of U.S. small cap managers, and 23% of international stock managers outperformed the relevant Standard & Poor’s benchmark. It’s clear that finding a manager that can add value by stock picking is a challenging feat.
We find it particularly interesting that active managers performed so poorly when the stock market was down in 2018. Proponents of active management suggest that their stock picking helps reduce the severity of the declines, so we should invest with them to help moderate the downside. If that were the case, we should have seen better results in down years.
In fact, looking at U.S. large cap manager performance during the last five stock market declines, we see little evidence that active managers are adding value when stock markets fall. U.S. stocks, as measured by the S&P 500 Index, fell in 2000, 2001, 2002, 2008 and 2018, and the percentage of managers that outperformed during those years was 63%, 45%, 42%, 35% and 31%, respectively. Only one of the five years saw managers outperform the index by more than 50%, and the trend is getting worse!
If you have any questions about your investments, need to inform us of any family or work-related changes, or want to discuss any financial planning needs, please reach out. We are here to help you reach your financial life goals!
Data source: Morningstar Direct, 2019, and 2018 SPIVA® U.S. Scorecard (S&P Dow Jones Indices). Diversification neither assures a profit nor guarantees against loss in a declining market. All investing involves risk, principal loss is possible. Implementing an asset class investing strategy cannot guarantee a gain or protect against a loss. Indexes are unmanaged baskets of securities in which investors cannot directly invest; they do not reflect the payment of advisory fees or other expenses associated with specific investments or the management of an actual portfolio.