What a difference a quarter, err a month, makes… After a modest but solid start for most areas of the market in 2014, September was the proverbial splash of cold water on one’s face. Almost all investment styles were hit relatively hard except for some areas within alternatives and the munis within fixed income. Unfortunately, many of the gains built up in July and August and from earlier in the year were trimmed or eliminated. Volatility, which we haven’t seen much of in a long time, finally picked up as investors got exceedingly nervous about expected rate increases from the Fed, not to mention some disappointing reports on US manufacturing, home prices, and consumer confidence. Then there are also tensions with Russia and continued economic weakness in Europe, Japan, and China. Investors continue to shrug many of these concerns off as evidenced by the relatively old age of this current Bull Run which started back in 2009, but could it be that we are finally heading for a “correction”?
Let’s look at the quarterly results and get back to that question later.
- Equities: According to Lipper, the average diversified U.S. Stock fund dropped 1.9% in the third quarter and brought the trailing twelve month (“TTM”) return to 12.0%. International stocks (represented by the MSCI World ex-US Index) were slammed in the third quarter, down 5.7%, and are now only up 4.9% in the last year. Basically, diversification away from large cap, which empirical studies show to benefit long-term returns, did not help in the short-run.
- Fixed Income: The average taxable bond fund was down 1.1% for the quarter as international and high-yields significantly underperformed, however remain up 3.6% for the last twelve months. Yields have remained low so far this year, yet rates are expected to surpass 1% in 2015 from its current near-zero level, and approach 4% by the end of 2017.
- Liquid Alternatives: As readers of our blogs know, a major purpose of having alternatives is to add diversification/protection benefits to your overall portfolio. In a month or quarter like this where most areas of the traditional market are heading south, one would like to have an asset class that’s totally uncorrelated, and thus heading in a better direction. Unfortunately, in the short term this isn’t always the case as evidenced by many of the most common forms of liquid alternatives losing some ground. (The Credit Suisse Liquid Alternative Beta Index was -0.4% for the quarter and now +4.8% TTM). That being said, an example of a good non-correlated fund and something that helps offset the damage elsewhere would be the AQR Managed Futures Fund (symbol: AQMNX). This fund was up 3.5% in September and up 5.33% for the quarter!
Of course, many of you may have not heard about how poorly most markets performed in September given how focused the media is on large-cap domestic stocks. Definitely CNBC and other major media outlets like to focus on the biggest stocks (i.e. those within the S&P500) and only a fraction of its time is spent reporting on other cap styles within equities and other asset classes like bonds or alternatives. It’s what happens when large caps are in vogue and diversification doesn’t appear to be doing its job.
However, we know better than to get caught up in the short term. As a CFA charterholder, one becomes very familiar with the empirical studies showing that the best way to invest for the long-term is to diversify and mitigate concentrated risk to any one particular area. Diversification benefits don’t always show up in small time periods (quarterly, yearly) but they pay off over the long-term. We live in a world that moves very quickly these days, but patience in investing is something that is prudent. Getting swept up in, and being over-exposed to the latest fad and chasing short-term performance are not rewarded in the end. The key is staying fully invested in accordance with an appropriate, well-diversified asset allocation based upon your risk tolerance. Using an experienced wealth manager like DWM can help you stay disciplined.
Here’s to an interesting final quarter for 2014!