Oct 07 2007
27 years of research says…
In July the Hulbert Financial Digest’s completed its 27th year of tracking the performance of investment-advisory newsletters. From the analysis of which strategies that have worked over the years, and a comparison of them with those approaches that have not, allowed Mark Hulbert to summarize some rational and investment lessons on investing.
One might be tempted to dismiss lessons learned from what happened as long ago as 1980, when many of today’s mutual-fund managers had not even graduated from elementary school. The Dow Jones Industrial Average on June 30th 1980 was then below 900, T-bills paid 11% interest and Hulbert Financial Digest began its research on managers and Financial newsletters and what they were saying.
But certain investment truths are timeless enough to transcend the year-to-year, or even decade-to-decade, cycles of the various financial markets.
Lesson #1: Returns in excess of 20% to 25% annualized are unsustainable.
Note carefully that this lesson that I draw doesn’t mean that no one is able to produce returns in excess of 25% in any given year. But no one adviser produces returns this large on a regular basis. Not even Warren Buffett, chairman of Berkshire Hathaway. Since 1980, the net asset value of Berkshire Hathaway has grown at an annualized rate of around 22%. But it had many years of negative returns.
Every newsletter and mutual fund among those that were monitored that has ever gained more than 100% in any given year has suffered through other years in which it produced big losses. Clearly, regression to the mean is a powerful force in the investment advisory arena.
Lesson #2: There is more than one road to riches
When Mark Hulbert started tracking investment managers and newsletters on June 30, 1980, He thought the research would provide answers to the holy grail of investing - investing at above average returns with little to no risk. He wanted to find out if the answers to the following questions
• Is Value better than Growth investing?
• Can you select the best country and industry to invest in, and time them consistently?
• Can you select the best way to invest in consistently?
Twenty-seven years later, He is no closer to answering these questions.
But one thing has changed. He now believe that it is good news that these questions do not get answered once and for all.
After all, if there were only one road to riches, it would get awfully crowded.
Consider the multiplicity of approaches that are represented by investment managers and the newsletters who according to the Hulbert Financial Digest, have made the most money over the last 27 years.
At the top of the list is a manager that advocates the long-term buying and holding of good quality Value stocks. The average holding period of positions is nearly six years. Neither market timing nor technical analysis plays an apparent role.
But consider the second-place investment manager. Its approach involves a combination of Growth investing both fundamental and technical analysis. The average holding period of its recommended stocks is less than six months.
It is difficult to think of a group of top performers with more disparate approaches.
Now look at the managers and newsletters with the worst performances over the last 27 years. One of the poorest performers is a newsletter whose approach is primarily, if not exclusively, growth and technical. But right above it is a newsletter that relied only on value investing and fundamental analysis.
He now is inclined to believe that almost any of the major approaches to investing can — in the right hands — be successful, Value or Growth. Yet in the wrong hands, those same approaches can be big disappointments.
Lesson #3: Discipline is the premier investment virtue.
A corollary of Lesson #2 leads me to this third lesson: The choice of investment approach is less important than what you add to the equation when following it.
What is this something else that can make all the difference between success and failure? Mark believes the answer is discipline.
Discipline is what keeps us from reacting impulsively and emotionally to what happens in our portfolios. It is a willingness to stick to a strategy during those temporary times it may be out of synch with the market.
Call it boring if you will. But, regardless, discipline is the key to your long-term investment success.
This is as true today as it was in 1980. And I’ll bet it will be just as true 27 years from now.
Lesson #4: Past performance is a helpful guide to picking an adviser — if it is measured over a long-enough period.
The Securities and Exchange Commission requires all investment advertising to concede that past performance is not a guarantee of future performance, but at the same time it is not the case — as some die-hard believers in the random walk contend.
For this column, Mark devised a test to show where we stand in between these two extremes. His test is based on choosing a manager or newsletter in January 2000. How would managers and newsletters have done over the seven and one-half years since then if they had been picked according to their past performance?
He chose January 2000 because it came right before a major market turning point, and junctures as big as that constitute particularly tough challenges for systems based on past performance. It was in early 2000, of course, that the Internet bubble burst and the stock market entered into a severe bear market during which the Dow Jones Industrial Average shed 38% and the Nasdaq Composite Index lost a stunning 78%.
Consider first the five managers/newsletters that, in January 2000, had the best performance over the trailing 12 months. Four of those five managers/newsletters still exist today, and their average return over the last seven and one-half years has been minus 2.9% on an annualized basis. The fifth of these manager/newsletters was discontinued in mid-2002; at that time, its return since January 2000 was minus 39.6% annualized.
Contrast these dismal results with the post-2000 returns of the five manager/newsletters that, in January 2000, were at the top of the rankings for performance since mid-1980, when the Hulbert Financial Digest first began monitoring managers/newsletters. Over the last seven and one-half years, these five manager/newsletters have produced an annualized return of 8.8%.
In other words, you would have improved your returns markedly in this decade if, in early 2000, you had focused on advisers with the best long-term returns as opposed to those who were playing a hot hand over the short term. The key is though concerntrating on the adviors and not the funds. When a fund changed a manager in most times the manager made the difference. so be careful when comapring long term results.
The bottom line? In my opinion, the random walkers are close to being right when performance is measured over the shorter term. But they become wrong in important ways when returns are measured over the very long term.
What this all means to you
#1 Don’t get caught up in things that give high returns, or compare an investment just becasue something else gives a higher return. Return is not the only measurement of success, risk taken is also important
#2 Just investing in value or in growth is not the only answer. Value is not the only way to success. Usually balancing between the two approaches makes sense over the long term and reduces the volatility of each investment style.
#3 Maintain your discipline, even when it looks tough, but only if it is structured with an understanding of risk.
#4 Look for investment managers that have a good long term track record of managing with returns and risk management
Rational - I had amnesia once — or twice.
