Looking up from the minutiae in order to see the big picture

Yesterday, I was chatting with someone about market returns since 2000. He mentioned with a chuckle an analyst who had stayed in bonds most of the past 8 years out of an aversion to risk assets, “that guy missed the boat big time,” he chuckled, “you can’t just be in bonds.”

Well, maybe you can’t. Or maybe you can. It really depends on one’s personal preference and assessment of relative risk. It also ought to depend on relative price, and one’s chosen investment discipline.

At our firm, we have not held only bonds for the past 8 years, so I am not here defending bonds only as “the best” strategy. At our firm, we (unlike 95% of investment advisors) are not passive, long always in our asset allocation. We actually make a constant effort to manage risk exposure for our clients. We don’t believe in tossing capital in, going golfing, and hoping it all works out.

So we have not lost money on the US dollar all through 2007. We had our clients out of it completely until just recently. We don’t look to hold equity investments while they plunge through bear market declines, because we don’t want to start from –20 to –40% losses when the next expansion cycle begins.

Sorry to say it plain, but an advisor who advocates passive asset allocation is really just someone with no buy or sell discipline. They have to give us the “we don’t try to time stuff” blarney, ’cause unfortunately, they don’t, and the blarney’s all they’ve got. Why clients would want to pay rich fees for such a service…well that’s another article for another day.

The truth that so many people miss in the minutiae is that a portfolio of high-quality government bonds and treasury bills actually would have offered better returns for most investors over the past 8 years than their passively allocated portfolios of domestic and international equities. Sure, if they were “fortunate” enough to match the Canadian index returns, then their Canadian equity holdings might have averaged 7% a year for the past 8 years. But that modest number masks a wild and jarring ride, which included losing over 30% of their value from 2000-2002 (more if they, like the majority, had a large chunk of Nortel or other high flyer stocks).

Through all of its ups and downs, it took the Canadian stock market 6 years of white-knuckle holding through the end of 2005 just to get passive investors back to the level they had started from in December 1999. And unfortunately, most Canadian investors did not just own Canadian equities throughout the past 8 years. Thanks to foreign equity diversification strategies, most Canadians also held passively some 30% to 50% of their account in US and international equities (also mostly denominated in US dollars).

Even after a 5-year bull cycle (2002-2007)–one of the longest ever in history–the S&P 500 is still some 5% below its previous high in 2000. The NASDAQ is still only half of the value it was at its 2000 peak. And in Canadian dollar terms, in net terms, Canadian investors lost well over 40% of their value on the currency while riding the US/international equity roller coaster for the past 8 years.

None of these gross return numbers take into account the additional dent of the considerable fees that the majority of investors paid their mutual fund companies and brokers for the privilege of these “rewards” throughout the past 8 years.

And so we see that a person who held Government of Canada bonds and T-bills throughout the past 8 years would actually have fared better than the vast majority of investors.

Those who avoided passive allocation strategies in equities over the past 8 years actually did not miss the boat. They caught the lifejacket. They missed out on the agony, angst and upset of large market losses and emotional trauma.

The long always industry is still selling everyone this passive, buy and hold bill of goods. And most investors, sadly, will continue to suffer the consequences unless, of course, they WAKE UP and see that there is a better way.