Getting your investments up to bat

Williams 150x150Dan Williams, CFA, CFPInvestment Analyst

With spring comes my favorite time of the year. Yes, the weather improves and the days get longer. However, for me, it is baseball season and corresponding fantasy baseball season that excites me. Baseball more than the other major sports is a game of statistics. It is engineered to be a series of one on one duels between a hitter and a pitcher such that individual contributions can be isolated. However, much like investing, a focus on the short-term and randomness leads even the most astute into a false knowledge of skill, and it is only through long-term analysis can truer knowledge be gained.

Consider a single at-bat between a hitter and a pitcher. The outcome is going to be a hit, an out, or a walk. If a hit occurs, especially if a home run, it is assumed that at least at that moment the hitter is very good and the pitcher is very bad. If an out occurs it is assumed the reverse. If a walk occurs the hitter has managed the least favorable of the positive outcomes and the pitcher has let the least unfavorable of negative outcomes happen. There is additional analysis that can be taken into the semantics of these three outcomes but the point remains that we have a data point of an individual success or failure. Similarly, in investing over the course of a quarter or year of performance of an investment fund we have an outperformance, underperformance, or an approximate market return relative to the corresponding benchmark and again additional stats can be gleaned from the performance such as standard deviation, upside capture, or attribution by sector selection vs. security selection.

In both cases after a short time period, a game for a hitter/starting pitcher or a quarter of performance for an investment fund, the temptation is very strong to extrapolate the just observed outcomes into the future. A successful hitter could have been lucky or was going against a poor pitcher (or a good pitcher who was having an off day). Similarly, an investment fund could have made a few lucky stock picks or was in a market environment that simply worked well with the strategy’s style of investing.

getting your investments up to bat

So does this mean we ignore the statistics of the short-term? That is, of course, foolish as the short-term is what happens as we build the data for the long-term. We always want to know what happened as it helps guide us to what will happen. It is simply wise to temper the conclusions we can draw from data over short periods. It is also humbling to know that even with ample data that can provide very close to proof of past greatness, it can never be fully relied on to provide future insight. At this point, I would say we have enough data to say Babe Ruth was a very good baseball player. However, he has been dead for about 70 years (so he is in a bit of a slump) and even if we through the miracle of science could resurrect a 30-year-old Babe Ruth, it is not a certainty he would achieve the same greatness in today’s baseball landscape. Similarly, an investment fund or strategy type that achieved great success over the long-term in the past may not achieve it in the future.

So where does this leave us? The recognition of great skill recognized solely in the short-term is unreliable and the great confidence we can achieve through the very long-term analysis thereof is not very useful. This leaves us striving for the middle ground. We look at performance data of at least a few market cycles and we additionally gain extra insight through qualitative data by talking to our investment managers and understanding the how of what they do. Through this process, we strive to send the right people up to bat and hopefully, we deliver more winning than losing seasons.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Investment Insights Podcast: 1 in 9.2 quintillion

Chris HartSenior Vice President

On this week’s podcast (recorded March, 16 2018), Chris talks about the parallels between March Madness and investing.

 

Quick hits:

  • Much like the task of filling out a perfect bracket, which currently stands at 1 in 9.2 quintillion, the chances of correctly predicting drivers of future returns is nearly impossible even for skilled investors.
  • Many have heard the term momentum in the stock markets, and behavioral finance will tell you that novice investors chase performance by allocating to last year’s winners under the guise that results for this year will be the same.
  • While picking the occasional upset is possible, most of the time fans are wrong relying on intuition or gut feel to pick an upset, and it costs them.
  • Brinker Capital knows how difficult it is to achieve successful outcomes, and has investment disciplines in place to help protect and build wealth over the long term.

For the rest of Chris’s insight, click here to listen to the audio recording.

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The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

There will never be a perfect time to invest

Crosby_2015-150x150Dr. Daniel Crosby Executive Director, The Center for Outcomes & Founder, Nocturne Capital

Consider something you’ve always wanted to do but that you’ve put off doing because it scares you. In fact, just think of something you’d eventually like to do but haven’t yet, since you may not even be aware of all your reasons for not having embarked on that journey just yet. Maybe that something is having a child. Maybe it’s starting a business. Or perhaps it’s writing a book, getting serious with a romantic partner, or any number of other aspirations you’ve yet to reach. Let’s say for discussion’s sake that the thing you are considering is starting a business. You ask yourself…

“Should I or shouldn’t I start a business?”

Easy enough, right? You make a t-chart, list the pros and cons and then make a decision! Well, let’s examine how you go about dissecting this question. You do your best to dispassionately weigh the pros and perils, but if you’re like most folks (and you are, remember, you’re not special) there is a flaw in the system. Drawing on his background in evolutionary psychology, James Friedrich has concluded that as we evaluate important decisions in our life, our primary aim is to avoid the most costly errors. That is, we make decisions that make us “not unhappy” rather than “blissful.” We want to be “not broke” more than we want to live abundantly. To use the above-mentioned example, you’re far more likely to focus on the potential perils of failing at business than you are the happiness and freedom that might accrue to you.

Never a good time to invest

The evolutionary roots of this system of self-preservation make sense. It was not all that long ago (in terms of evolutionary time) that our forebears were called upon daily to make life and death decisions. For people living on the savannahs of Africa, choosing to zig when you should have zagged could spell the end. Historically, decision-making has been very wrapped up in preserving physical safety and ensuring that physical needs were met. In this life-and-death scenario, minimizing risk at the expense of self-actualization is only logical. However, in the intervening millennia, things have changed and our thought patterns have not kept pace. At least in the US, we now live in a service economy that produces more ideas than it does “things.” We have moved from an agrarian to an industrial to a knowledge-based economy and our ability to cope with personal stressors has not kept pace.

What we are left with is a brain and a decision-making modality that is ill-suited for our modern milieu. We are programmed to choose safety, even at the expense of joy, in an environment where safety abounds and joy is hard to find. Daniel Kahneman and others have shown that people are twice as upset about a loss as they are pleased about a gain. Unless we learn to train our brains to evaluate risk and reward on a more even keel, we will remain trapped in a life of risk-aversion that keeps us from taking the very risks that might make us happy.

Because of the asymmetrical means by which we evaluated risk, it could be truthfully and plainly said that there is never a good time to invest…or have a baby…or start a business…or fall in love. After all, each of these requires us to make ourselves vulnerable, either personally, financially or both, to an unknown future with a very real downside. Markets crash, kids talk back, and businesses fail. But a life lived in shades of grey is the only thing less satisfactory than a life lived at risk of loss. There will always be worries, some founded, others not and investors who are paying attention will never have a sense that it is “all clear.” This uncertainty, this pervasive not knowing, is the hallmark of both life and capital markets and those that have mastered both come to love and embrace it.

The Center for Outcomes, powered by Brinker Capital, has prepared a system to help advisors employ the value of behavioral alpha across all aspects of their work – from business development to client service and retention. To learn more about The Center for Outcomes and Brinker Capital, call us at 800-333-4573.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Investment Insights Podcast: The complacency of markets so far in 2017

Jeff Raupp, CFARaupp_Podcast_GraphicDirector of Investments

On this week’s podcast (recorded August 7, 2017), Jeff discusses how in an upward trending market like this, investors often start overestimating their risk appetite.

Quick hits:

  • This past Friday marked the 34th record high for the Dow Jones Industrial Average in 2017.
  • The largest market drawdown that we’ve experienced in 2017 is just 3%.
  • The key to long term investing is choosing a good long-term strategy that you can stay with through up and down markets.

For Jeff’s full insights, click here to listen to the audio recording.

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The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

Diversification: It’s Not Beauty and the Beast, but Still a Tale as Old as Time

Crosby_2015Dr. Daniel Crosby, Executive Director, The Center for Outcomes & Founder, Nocturne Capital

Hedge fund guru Cliff Asness calls it “the only free lunch in investing.” Toby Moskowitz calls it “the lowest hanging fruit in investing.” Dr. Brian Portnoy says that doing it “means always having to say you’re sorry.” We’re speaking, of course, of diversification.

Diversification, or the reduction of non-market risk by investing in a variety of assets, is one of the hallmarks of traditional approaches to investing. What is less appreciated, however, are the ways in which it makes emotional as well as economic sense not to have all of your eggs in one basket. As is so often the case, the poets, philosophers and aesthetes beat the mathematicians to understanding this basic tenet of emotional self-regulation. The Bible mentions the benefits of diversification as a risk management technique in Ecclesiastes, a book estimated to have been written roughly 935 BC. It reads:

But divide your investments among many places, for you do not know what risks might lie ahead. (Ecclesiastes 11:2)

The Talmud too references an early form of diversification, the prescription there being to split one’s assets into three parts—one third in business, another third in currency and the final third in real estate.

The most famous, and perhaps most eloquent, early mention of diversification is found in Shakespeare’s, The Merchant of Venice, where we read:

My ventures are not in one bottom trusted,

Nor to one place; nor is my whole estate

Upon the fortune of this present year:

Therefore my merchandise makes me not sad. (I.i.42-45)

It is interesting to note how these early mentions of diversification focus as much on human psychology as they do the economic benefits of diversification, for investing broadly is as much about managing fear and uncertainty as it is making money.

Don't put your eggs in one basketBrought to the forefront by Harry Markowitz in the 1950s, diversification across a number of asset classes reduced volatility and the impact of what is known as “variance drain.” Variance drain sounds heady, but in a nutshell, it refers to the detrimental effects of compounding wealth off of low lows when investing in a highly volatile manner. Even when arithmetic means are the same, the impact on accumulated wealth can be dramatic. (This is not the same as the more widely used annualized return numbers, as they account for variance drain, but for this illustration, we’ll look specifically at variance drain.)

Say you invest $100,000 each in two products that both average 10% returns per year, one with great volatility and the other with managed volatility. The managed volatility money rises 10% for each of two years, yielding a final result of $121,000. The more volatile investment returns -20% in year one and a whopping 40% in year two, also resulting in a similar 10% average yearly gain. The good news is that you can brag to your golf buddies about having achieved an average return of 40%—you are an investment wizard! The bad news, however, is that your investment will sit at a mere $112,000, fully $9,000 less than your investment in the less volatile investment since your gains compounded off of lower lows. (To account for this, the investment industry uses annualized returns, which account for variance drain, rather than average returns.)

Managing variance drain is important, but a second, more important benefit of diversification is that it constrains bad behavior. As we’ve said on many occasions, the average equity investor lags the returns of the equity market significantly. It is simply hard to overstate the wealth-destroying impact of volatility-borne irrationality. The behavioral implication of volatile holdings is that the ride is harder to bear for loss-averse investors (yes, that means you).

As volatility increases, so too does the chance of a paper loss, which is likely to decrease holding periods and increase trading behavior, both of which are correlated with decreased returns. Warren Buffett’s first rule of investing is to never lose money. His second rule? Never forget the first rule. The Oracle of Omaha understands both the financial and behavioral ruin that come from taking oversized risk, and more importantly, the power of winning by not losing.

DiversificationAt Brinker Capital, we follow a multi-asset class investing approach because we believe that broad diversification is humility in practice. As much as experts would like to convince you otherwise, the simple fact is that no one knows which asset classes will perform well at any given time and that diversification is the only logical response to such uncertainty. But far from being a lame concession to uncertainty, the power of a multi-asset class approach has the potential to deliver powerful results. Take, for example, the “Lost Decade” of the early aughts, thusly named because investors in large capitalization U.S. stocks (e.g., the S&P 500) would have realized losses of 1% per annum over that 10-year stretch. Ouch. Those who were evenly diversified across five asset classes (U.S. stocks, foreign stocks, commodities, real estate, and bonds), however, didn’t experience a lost decade at all, realizing a respectable annualized gain of 7.2% per year. Other years, the shoe is on the other foot. Over the seven years following the Great Recession, stocks have exploded upward while a diversified basket of assets has had more tepid growth. But the recent underperformance of a diversified basket of assets does nothing to change the wisdom of diversification; a principle that has been around for millennia and will serve investors well for centuries to come.

Diversification does not assure a profit or protection against loss. The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, a Registered Investment Advisor.

Everyone’s Unique

Jeff Raupp Jeff Raupp, CFA, Senior Investment Manager

Whenever I go to the bowling alley it strikes me how unique people are. And no, it’s not because of the multi-colored shoes or even the matching team jackets complete with catchy names like “Pin Pals” or “Medina Sod” sewn on the back. It’s because of the bowling balls.

Every time I head to the lanes, I can bank on spending at least ten minutes trying to find a ball that works for me. You have the heavy balls with the tiny finger holes and the huge thumb, the balls with the finger holes on the other side of the ball away from the thumb, and the ones where it seems like someone was playing around and drilled three random holes. Half of the time I find myself weighing the embarrassment of using a purple or pink ball that feels okay versus a more masculine black or red ball that weighs a ton but can only fit my pinkie. I’m always left thinking, “Where’s the guy or gal that this ball actually fits?”

Raupp_Everyones_Unique_2.14.14But at the end of the day, I find that if I find the right ball, where my hand feels comfortable and the weight is just right, I have a much better game.

In the same way, how to best save toward your life goals is unique to each investor. Even in the scenario where two investors have the same age, same investable assets and generally the same goals, the portfolio that helps them achieve those goals may be decidedly different between them. Investor emotion can play a huge role in the success or failure of an investment plan, and keeping those emotions in check is vital. There is nothing more damaging to the potential for an investor to meet their goals than an emotional decision to deviate from their long-term strategy due to market conditions.

Fortunately, there’s often more than one way to reach a particular goal. There are strategies that focus on total return versus ones that focus on generating income. Strategies that are more market oriented versus those that look to produce a certain level of return regardless of the markets. And there are tactical strategies and strategic strategies. For any investor’s personal goal(s), several of these, or a combination of these, might provide the necessary investment returns to get you there.

Raupp_Everyones_Unique_2.14.14_1Here’s where the emotions can come into play—if you don’t feel comfortable along the way, your emotions can take over the driver’s wheel, and your investor returns can fall short of your goal. In 2008-2009, many investors panicked, fled the markets, and decided to go to cash near the market bottom; but they missed much of the huge market rebound that followed. While in many cases the investors pre-recession strategy was sound and ultimately would have worked to reach their goals, their irrational decision during a period of volatility made it a tougher road.

Unfortunately, you don’t have the benefit of rolling a few gutter balls while you’re trying to find the right portfolio. That’s why working with an expert to find an investment strategy that can get you to your goals, and that matches your personality and risk profile, is vital to success.

Good bowlers show up at the alley with their own fitted ball and rightly-sized shoes. Good investors put their assets in a strategy fitted to their goals.

Economic Headwinds and Tailwinds

Magnotta @AmyMagnotta, CFA, Brinker Capital

We continue to approach our macro view as a balance between headwinds and tailwinds. The scale tipped slightly in favor of tailwinds to start the year as we saw a slight pickup in the U.S. economy, some resolution on fiscal policy, and even more accommodative monetary policy globally. However, we continue to face global macro risks, especially in Europe, which could result in bouts of market volatility. The strong market move in the first quarter, combined with higher levels of sentiment, and a potentially disappointing earnings season, may leave us susceptible to a pull-back in the near term, but our longer-term view remains constructive. While the second quarter may bring weaker growth in the U.S., consensus is for economic activity to pick up in the second half of the year.

Tailwinds
Accommodative monetary policy: The Fed continues with their Quantitative Easing Program and will keep short-term rates on hold until they see a sustained pickup in employment. The European Central Bank has also pledged support to defend the Euro and has committed to sovereign bond purchases of countries who apply for aid. Now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. The markets remain awash in liquidity.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be put to work through M&A, capital expenditures or hiring, or returned to shareholders in the form of  dividends or share buybacks. While estimates are coming down, profits are still at high levels.

Housing market improvement: The housing market is showing signs of improvement. Home prices are  increasing, helped by tight supply. The S&P/Case-Shiller 20-City Home Price Index gained +8.1% for the 12-month period ending January 2013. Sales activity is picking up and affordability remains at high levels. An improvement in housing, typically a consumer’s largest asset, is a boost to confidence.

Equity Fund Flows Turn Positive:  After experiencing years of significant outflows, investors have begun to reallocate to equity mutual funds. Investors have added over $67 billion to equity funds so far in 2013 (ICI, as of  3/27/13), compared to outflows of $153 billion in 2012. Investors continue to add money to fixed income funds as
well ($70 billion so far this year).
shutterstock_112080815
Headwinds

European sovereign debt crisis and recession: The promise of bond purchases by the ECB has driven down borrowing costs for problem countries and bought policymakers time, but it cannot solve the underlying  problems in Europe. Austerity measures are serving only to weaken growth further and cause higher unemployment and social unrest. After how it dealt with Cyprus, there is again risk of policy error in Europe.  We are also closely watching the Italian elections in June after February’s elections were inconclusive.

U.S. policy uncertainty continues: After passing the fiscal cliff compromise to start the year, Washington passed a short-term extension of the debt ceiling and more recently agreed on a continuing resolution to avoid a government shutdown. The sequester, which was temporarily delayed as part of the fiscal cliff deal, went into effect on March 1. The automatic spending cuts have not yet been felt by most, but it will soon start to show  up in the second quarter and will shave an estimated 0.5% from GDP. In addition, the debt ceiling will need to be addressed again this summer.

Geopolitical Risks:
Recent events in North Korea are cause for concern.

This commentary is intended to provide opinions and analysis of the market and economy, but is not intended to provide personalized  investment advice. Statements referring to future actions or events, such as the future financial performance of certain asset classes, market segments, economic trends, or the market as a whole are based on the current expectations and projections about future events provided by various sources, including Brinker Capital’s Investment Management Group. These statements are not guarantees of future performance, and actual events may differ materially from those discussed. Diversification does not ensure a profit or protect against a loss in a declining market, including possible loss of principal. This commentary includes information obtained from third-party sources. Brinker Capital believes those sources to be accurate and reliable; however, we are not responsible for errors by third-party sources on which we reasonably rely.

The Law of Unintended Consequences

Andy RosenbergerAndrew Rosenberger, CFA, Brinker Capital

History is littered with examples of “unintended consequences” – a term referring to the fact that decision makers (and more importantly, policymakers) tend to make decisions that later have unforeseen outcomes.  I was reminded of such a fact this weekend as my wife and I launched into our annual (and seemingly unending) springtime yard cleanup.   In addition to the mulching, planting, trimming, and other routine undertakings associated with yard maintenance, every year, we spend more time and money than I care to admit trying to rid our yard of the dreaded English Ivy.  As any other homeowner with a similar problem can sympathize with, there is no amount of weed killer, weed-whacking or online product remedies that seem to tackle the problem.  Our English Ivy problem is the unintended consequence of the prior homeowners’ decision to turn their yard into an “English Garden”.

On a much grander scale, unintended consequences pop up everywhere.  Most go unnoticed by the broader public.  As one such example, The Wall Street Journal recently ran an article titled “U.S. Ethanol Mandate Puts Squeeze on Oil Refiners”.  The article highlighted that consumers could see higher prices at the pump due to government enacted mandates that force refiners to purchase market-based ethanol credits.  The original idea was that increasing the amount of ethanol used in gasoline would make gasoline cleaner burning and be better for the environment.  However, since the policy was enacted, two unforeseen issues have unfolded.  First, prices for these ethanol-based credits have skyrocketed in the past few months.  The higher ethanol credit prices mean that refiners will be forced to pass along higher prices for gasoline to the end consumer.  Second, automakers are suggesting that cars and trucks aren’t well equipped to burn the new gasoline blend.  As a result, we have a policy that was intended to produce cleaner burning gasoline which ultimately turned into higher gas prices for a product which most cars aren’t able to use.

consequencesThe reality is that the vast majority of consumers will never be informed of policy misstep.  Only industry experts and select individuals with knowledge of the matter will truly understand the costs involved.  Sometimes; however, unintended consequences have a much more visible impact on the broader economy.  That’s been the case over the past two weeks as policymakers have tried to tackle the banking problems in Cyprus.  If we rewind to last year, Greece was the conversation of topic.  Ultimately, policymakers decided that private sector bond holders should bear the brunt of the losses on Greek debt.  Fast forward to today and we have insolvent Cyprus banks.  Why?  Because Cyprus banks, which were one of the largest holders of Greek debt, were forced to write-down their assets.  So while at the time the policy of having private sector investors take the loss on Greek debt seemed like a good idea, ultimately the unintended consequence was that it would later result in Cyprus banks becoming woefully undercapitalized.

The European Union’s response to the Cyprus banking issue was subsequently just as perplexing.  As initially proposed, depositors, regardless of their size, would be taxed to cover the insolvency of the local banks.  Ultimately, while the policy was later reversed to preserve deposits below €100,000, the sanctity of small deposits suddenly disappeared.  Most market pundits will agree that Cyprus is too small and irrelevant in the grand scheme of things to bring down the European economy.  I worry, however, that the unintended consequence of Europe’s policy response will make depositors in other peripheral countries a bit more anxious when it comes to where they store their money for safekeeping.  After all, one of the tenants within economics is that if two investments have equal return, investors will choose the one with lesser risk.  With interest rates near 0% across the developed world, wouldn’t it make the most sense for depositors to store their wealth in a place with little chance of future default?  While we often like to believe that these matters are completely thought through and weighed carefully by policymakers, unfortunately, this most recent policy decision appears to driven more for domestic political purposes as opposed to European “Union” driven.

The War Against Your Credibility

Sue BerginSue Bergin

While you were enjoying some quiet family time on Sunday morning, America’s most read magazine was advising its readership to dump you.

In an article “How to save $1,000 this year,” Parade magazine tells its 33 million readership that the average investor could save $750 if they moved to a self-directed IRA.

In case you missed it, here is the excerpt:advice ahead

Shed Investment Fees

It’s one of the quickest ways to save …. Consider rolling over 401(k) assets from old jobs into a self-directed IRA.  Since the average 401(k) is $75,0000 saving 1 percent makes sense.  Potential Savings:  $750 per year.

The article fails to mention is that the average U.S. individual stock investor doesn’t fare very well.  In fact, they typically get significant lower returns than the S&P.  Over a recent five-year period, the average U.S. investor got an annual return of just 1.9%, while the S&P 500 returned 8.4%.[1]

The do-it-yourself investment management trend is gaining momentum in the media.  This is just the latest example.  Know that there is a war being waged against your credibility and the value you bring to your relationships.

Fight back.


[1] The Most Destructive Behavioral Bias, Summer 2012, The Journal of Investing

Economic Headwinds and Tailwinds

We continue to approach our macro view as a balance between cyclical tailwinds and more structural headwinds. While we have seen some improvement in the economy and strong global equity markets, helped by easy monetary policy, we continue to face global macro risks and uncertainties. The unresolved risks could result in bouts of market volatility. As a result, portfolios have a modest defensive bias, and are focused on high conviction opportunities within asset classes.

To read more, click here

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