At ValueTrend, as the name suggests, portfolio management is driven by value-based principles. But, says portfolio manager Keith Richards, any system worth its salt will save you in the long run, as long as you stay with the active approach.
For a long time now, there has been much debate over the value of active portfolio management. One of the best resources for determining that value is the SPIVA® (S&P Indices Versus Active) report, which provides updated statistics on how active portfolio managers are faring against the broad liquid market indices. It’s a good site to check how many managers outperform their index in virtually every developed market. In fact, the report can be a bit eye opening.
For example, the report notes that, “88.30 per cent of US large-cap funds underperformed the S&P 500 over 5 years” and “70 per cent of Canadian equity funds underperformed the S&P/TSX over 5 years”.
There are a couple of things to keep in mind when viewing the data. First, the data changes and manager performance can rotate in and out of favor on occasion. So, the SPIVA® report is an average for a group.
Evaluating individual managers
But it’s less significant as a tool for evaluating individual portfolio managers. This is because in any given period (1 year, 3 year, 5 year, etc.), some managers move up into the ‘outperforming’ group while others drop out of it. Thus, the active managers may be constantly rotating in and out of relative performance. For example, in 2016, many true value managers were hammered—growth stocks were king. One of the purest value managers out there might be the ABC Fundamental Value Fund. Reading their statistics, you would have seen that they underperformed the Canadian TSX300 by a huge margin over their two-year performance to July 31, 2017. However, their one-year performance to July 31, 2017 was more than double the index’s performance.
Helpful, but no holy grail
Clearly, ABC’s style of valuation and trading came back into favor. I’m not here to endorse them or any mutual fund. (In fact, I tend to advise against buying funds for their costs and their inability to react in a down market.) But I am pointing out that ABC’s returns were thrown into the pool for performance numbers in studies like SPIVA®. You can see that these statistics cannot remove ‘bad years’. Yes, it all comes out in the wash, but one bad year can be misleading, and might have prevented you from buying a fund that doubled the index a year later.
Further, if you get truly active management—that is, a manager or style of manager unafraid to raise cash, short, or hedge risk—the SPIVA® report may not encourage you to invest with them before a market crash. Leading into 2008, the average hedge fund was underperforming. Such reports would have discouraged you from investing in them. Ironically, in 2008 hedge funds (on average) outperformed the market.
Active vs. index
The chart of the S&P 500 over the past 20 years amply demonstrates the effect that the 2001 and 2008 crashes had on stock portfolios. The indexes were clobbered. From the 2000 peak, it took index investors about 6 years to break even (early 2007). Same with the 2008 peak—it was a 5-year journey (mid-2013) to become whole again for index investors. Personally, I know of many individual investors and good portfolio managers who broke even in far less time than 5-6 years. Our Equity Platform was fully recovered by the first quarter of 2009 after the ’08 crash.
Some managers, like ourselves, prefer a steady type of return over the more volatile index returns. In such cases, it’s hard to play the ‘me too’ game of chasing irrational exuberance during a fast-rising market. Cap-weighted indices such as the TSX300 and S&P500 tend to overweight the current market darlings. And that’s OK, so long as markets are rising. However, performance with lower, standard deviation from a mean (average) return is hard to achieve while you chase index-leading stocks that are becoming overbought.
At ValueTrend, we’ve outperformed over most time periods. Having said that, we still go through periods of underperformance just like any other manager. For example, we sometimes make a decision to hold cash while others gleefully pile into the market—such as now. Sometimes we’re wrong and wish we’d bought. But when we’re right, we’re right. Our biggest and best years are during times when markets act irrationally. That’s a management style that may go out of favor for a while, but the ‘trend’ is for us to regress back to our mean performance. So, in the near term, we might be added to the ‘underperforming the index’ group—as other managers may be. But any system worth its salt will save you in the long run.
Whether you manage your own money or use a portfolio manager, stay with the active approach. It’s worth the safety—should the market turn ugly.
Keith Richards, Portfolio Manager, can be contacted at firstname.lastname@example.org. He may hold positions in the securities mentioned. Worldsource Securities Inc., sponsoring investment dealer of Keith Richards and member of the Canadian Investor Protection Fund and of the Investment Industry Regulatory Organization of Canada. The information provided is general in nature and does not represent investment advice. It is subject to change without notice and is based on the perspectives and opinions of the writer only and not necessarily those of Worldsource Securities Inc. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance, or achievements could differ materially from any future results, performance, or achievements that may be expressed or implied by such forward-looking statements and you will not unduly rely on such forward-looking statements. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please consult an appropriate professional regarding your particular circumstances.
This is an edited version of an article that was originally published for subscribers in the September 2017/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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