2016 Q1: Time, Diversification & Volatility of Returns

Posted by on Apr 15, 2016 in MFA Quarterly Commentaries

Although it didn’t start that way, the first three months of 2016 produced moderately positive returns for client portfolios.  At the midpoint of the quarter we saw headlines in the Wall Street Journal such as: Stocks Tumble as Investors Flee to Safety”.  At times like this it can appear that we aren’t earning the returns we typically use in our long-term financial planning.  Investment returns are disappointingly low after two severe market corrections in the last fifteen years.

Being diversified among different types of stocks as well as fixed income (bonds) allows us to ride out the volatility that accompanies higher expected returns.  And riding things out is no small feat.  Following the weakness of global stocks over the last twelve months, it is a good time to point out that long-term stock market returns should continue to outperform bonds by a significant factor (especially with low rates).

Stock markets are inherently erratic and unpredictable in the short term but history shows that they should be expected to be more productive over the long run.  As the chart below indicates, there has not been a 20 year period in the 65 years since 1950 in which US stocks have earned less than 7% annually, shorter time frames include instances of losses.

Our attached performance reports don’t have a section that shows avoided losses but we have kept clients from many mistakes over the years.  The most common issue, with new clients especially, is too much cash sitting idle – which becomes a drag on long term performance.

Over the last few years, many investors have been tempted by advertisements trumpeting the promise of higher returns from high yield (junk) bond funds (6% + reported yields were not uncommon).   We have always avoided high yield bonds due to their “stock-like” risk – we don’t view them as a fixed income (bond) investment.  To prove our point, high yield bonds as measured by the SPDR Barclays High Yield Bond ETF are down nearly 8% in the last 12 months and -0.35% per year for the 3 year period ended 04/05/2016 (Source: Morningstar).

Another area in which investors reached for yield has been master limited partnerships (MLPs – essentially companies that own oil and gas pipelines and were touted as safe toll takers).  Perhaps some of your friends bragged about “double digit” MLP returns a few years ago.  We’re guessing they may have neglected to keep you current.  As measured by an MLP index ETF (AMLP), master limited partnerships have been crushed in the last twelve months (down 32%).  When we considered MLPs years ago, we understood that a portion of those “returns” were investors principal coming back to them from an investment too concentrated in a single sector for our taste.

While we empathize with the concern with the low single digit returns over fairly long time periods from our globally diversified portfolios, we are confident that patience and perseverance will pay off.   It is impossible to know when overall returns will look more “normal”, what we can say with certainty is that we are at the long end of a period of historical global stock underperformance.

We’re happy to discuss this or other aspects of your financial or investment plan with you at your convenience.