We talk quite a bit about our investment philosophy and process being evidence-based. What that means is that we partner with firms who study long-term historical market data and investor performance and who help us understand and implement practical academic and industry research that we believe will directly benefit our clients. That evidence causes us to stay clear of many of the traditional approaches to investing like stock picking and market timing.
With an evidence-based philosophy, we always remain 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 statements 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 they are willing and able to take.
That advice of staying invested and diversifying paid off. Global stocks surged in the first quarter of 2019 and are now 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 often 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 mangers 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, especially when one factors in the added investment costs and accelerated taxes that often accompany an active approach.
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. In only the first of those five declining years did more than 50% of active managers outperform the index, and the trend since then has not been good!
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 let us know. 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.