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Fourth Quarter 2013 Newsletter

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SURVIVOR

I'm a survivor
I'm not gon give up
I'm not gon stop
I'm gon work harder
I'm a survivor
I'm gonna make it
I will survive
Keep on survivin'


Back before Beyoncé used a single name, before she married Jay Z and named her daughter “Blue Ivy”, and before she became a close friend to the Obamas, she was simply a talented teenage singer. Back when her mom made her costumes and her dad was her manager, Beyoncé Knowles and two other girls performed on an album entitled “Survivor”. You probably remember the hit single on that album by the same name. (The song’s beautifully poetic refrain is printed above.) But you probably didn’t know that this 2001 album contained three other #1 hits, earned three Grammy nominations and was certified quadruple platinum. All this took place before she ever became a solo artist. Then she really became famous. She has done a great job of remaining relevant and sober in a remarkably competitive business. Diana Ross, Britney Spears, Mariah Carey, Whitney Houston and a host of others all went through their crazy-acting, substance-abusing, rehab-staying days. But not Beyoncé. At least, not yet. For this feat, she should be commended. She has been a particularly effective survivor in a tough industry.


Survival in the mutual fund industry is also difficult. Most investors don’t realize that a significant number of mutual funds do not survive for meaningful periods of time. When some die off, they literally close the doors and return cash to shareholders. But more often than not, these poorly performing funds are merged into another fund within the same fund family. How often does this happen? Quite often. For example, for 5 year and 10 year periods ending 12/31/2012, the survival rate was 70% and 51%, respectively. You read that correctly. Over a decade, almost ½ of all equity mutual funds become extinct. (DFA, Inc. 2013)


You may think that owning the survivors might give you a better chance to outperform, but that would be an incorrect assumption. The chance of choosing an outperforming actively managed mutual fund is small. For example, for 10 year periods ending 12/31/2012, here are the records of underperformance vs. the style benchmark, which includes those funds that didn’t survive (DFA 2013):

  • Large Cap Blend funds underperformed 89% of the time
  • Mid Cap Blend funds underperformed 91% of the time
  • Small Cap Blend funds underperformed 89% of the time
  • International funds underperformed 80% of the time


It also doesn’t help to try and buy funds that had a superior performance in the past. Studies show that choosing to buy an equity mutual fund that performed in the top quartile (25%) in the last 3-5 year period would only give you about a 1 in 4 chance of being in the top quartile for the next 3-5 year period. You’d have just as much chance of being in the bottom quartile. (DFA 2013)


So what’s an investor to do? If you are a regular reader of this report, you probably know the answer. But just to make sure, let’s run down the basics, first listing the problems with trying to beat the benchmark:

  1. Active mutual funds that outperform their benchmarks are in the small minority.
  2. Strong records of outperformance typically do not persist.
  3. High costs of trading and turnover hurt active funds’ performance.
  4. Active funds that do outperform typically cannot be discovered early enough to take advantage of that fact.


Now let’s review the path to long term investment success:

  1. Don’t try to guess what the market will do.
  2. Set up a risk/reward plan that meets your objectives and investment temperament.
  3. Invest in diversified asset classes via passive funds, using Modern Portfolio Theory.
  4. Low cost and low turnover allow for higher returns and tax efficiency.
  5. Rebalance asset classes to keep your risk/reward parameters consistent.
  6. Stick to the plan, especially in difficult market times.
  7. Focus on full market cycle returns, not quarterly or annual results.


Many of our long term clients have seen these rules work in real time, even during time periods reflecting some of the most difficult stock markets in history. You might call them survivors. We call them great investors.


ANNUAL HOUSEKEEPING


Each year at this time we follow federal law and include DHGWA’s Privacy Statement with this letter. In addition, we offer you our Form ADV Part II – a Disclosure Document required by and filed with the Securities Exchange Commission. We update this document at least annually. It’s a real page-turner. Please contact Kevin Broadwater at 828-236-5801 or kevin.broadwater@dhgwa.com if you would like us to send or email you a copy. You can also find our ADV on our website (www.dhgwealthadvisors.com). Lastly, we would like to remind you to keep us informed of anything happening in your life that may have ramifications to the risk/reward parameters of your portfolio. We can only be of maximum value to you if we have full knowledge of your current financial situation.


FOURTH QUARTER AND FULL YEAR 2013 ASSET CLASS PERFORMANCE
FOURTH QUARTER AND FULL YEAR 2013 ASSET CLASS PERFORMANCE


The broad domestic stock market had its best year since 1997. The fourth quarter continued where the third left off. Value stocks modestly outperformed growth, but both large and small companies performed similarly. International stocks, while very positive, didn’t approach the double digit returns of their US counterparts. Both domestic and international real estate had fractional negative returns for the quarter and low single digit returns for the year. This is in comparison to International Real Estate’s equity asset class leading performance for the year 2012. Emerging markets also had a tough year compared to their industrialized counterparts, eking out positive returns for the quarter, but experiencing losses for the full year.


One of the unique features of this extraordinary market year was the relatively low level of volatility experienced in 2013. With record highs, one might have expected a lot of instability or big up and down trends. This was not the case. In 2013, the Dow Jones Industrial Average experienced only 4 days that had a 2% or greater up or down move, the fewest since 2006. See the small chart of the S&P 500 regarding the smoothness of the gain in the markets during 2013.


The great performance of the market was counterintuitive to various news events that took place during the year. We started out with the “fiscal cliff”, had a partial government shutdown, worried about the ability of Congress to agree on a debt ceiling, misinterpreted the start of the Fed tapering its artificial buying sprees, and discovered there were not enough geeks involved in building Obamacare’s website. Then sprinkle in the international news from Europe and Chinese economies, and you had even more reason to be nervous. But through it all, the market continued to move up. The economy did its best imitation of the little engine that could. Housing continued to make up for lost time, with price increases and new construction making new highs since the 2007 market top. Real GDP (gross domestic product) hit a surprisingly robust 4.1% in the third quarter. Unemployment slowly decreased from 7.8% to 7.0% at year end, and is projected to hit 6.5% by the end of 2014. Inflation stayed low, despite T-Bill rates at basically 0% for the last four years. All the while, US corporations continued to increase their earnings, fueling the year’s excellent market performance.


We should not expect a continuance of 2013’s huge equity returns in 2014. Our advice is to not focus on quarterly and annual returns, but rather view your progress in terms of full market cycles. As long term investors, our clients’ goals are to generate very efficient returns, defined as maximizing returns consistent with your chosen level of risk. The last two years were the flip side to the market downturn of 2008-9. Equity returns don’t come in consistent intervals, but in pushes and pulls that test our psyche’s ability to deal with the emotions of fear and greed experienced during bull and bear market years. You should expect superior long term returns from the equity asset classes in your portfolio, but that performance is accompanied by higher volatility. We use Modern Portfolio Theory and low cost, institutional passive asset class vehicles to help make the ride as comfortable as possible. That is the formula for long term success, regardless of the short term fluctuations we experience.


Celebrate the returns of last year and those New Year’s resolutions that you haven’t already discarded. There is probably more life in this bull market, but it may not come as effortlessly as it has the last few years. Enjoy the winter weather, stay warm, and cheer on our Olympic athletes in February.


Sincerely,


Frederick F. Kramer IV, JD
Chief Investment Officer
Dixon Hughes Goodman Wealth Advisors LLC