We recently published a post discussing the propensity of investors in the aggregate to make wild swings in and out of markets, and the damage that this type of behavior tends to cause to their investment performance.
We have always believed that following a consistent investment discipline provides much better results over time. This does not mean that we advocate a "buy-and-hold" approach: we believe in the importance of diligently seeking out businesses which are well-positioned for exceptional performance, and closely monitoring those businesses once we commit capital to them, replacing them when necessary.
Here is a link to a recent article entitled "Investors sour on pro stock pickers," discussing large flows of investment dollars away from "active managers" and towards ETFs, based on dissatisfaction with the performance of active managers and the general belief that ETFs offer a better deal. While we do believe that there can be problems with the way some "active" funds are managed, we have also written about the concerns we have over the ETF model.
We would also point out that these kinds of major swings from one management model to another are very similar to the swings from stocks to bonds and back to stocks that we discussed in the previous post. It is certainly important to make changes when warranted, but it is also clear from history that going along with the endless stampeding of the "herd of money" from one extreme to the other can be very harmful.
We believe that a consistent process based on time-tested convictions about businesses is a better way. Above we post our performance history through the most-recent quarter to back up those convictions and the principles that we advocate here on the blog.
For GIPS disclosures and other information, seehere.
Recently on his Calafia Beach Pundit blog, Scott Grannis pointed out the data that shows what he terms "an impressive exodus of investors from domestic equity funds over the past several years." As the chart above illustrates, using fund flow data from the venerable Investment Company Institute (ICI), there is no denying the exodus that Mr. Grannis describes. We believe this is significant and worth some further comment.
The chart above depicts the ICI data of monthly total dollar flows into (or out of) equity mutual funds as a red line, and the monthly total dollar flows into (or out of) bond mutual funds as a blue line. The scale on the left measures the flows in millions of dollars, with a zero line in bold. When net flows for a month are positive for equity funds, for instance, the red line will be above the bold zero line. When net flows for a month are negative for equity funds, the red line will be below the bold zero line (a net "negative inflow").
As Mr. Grannis observes, the equity market recovery that has taken place since the financial market panic and recession of 2008-2009 has occurred in spite of very heavy outflows of investor dollars from equity mutual funds. A few notable months are marked above, in red letters for equity and blue letters for bonds. For instance, in September 2008, equity mutual funds experienced net outflows of fifty billion dollars in investor assets. The following month the stampede out of equity funds was even heavier, with a whopping seventy billion additional dollars leaving equities. The same month, bond funds were also experiencing heavy redemptions, with over forty-one billion dollars exiting bond funds in October 2008 (not marked on the chart but clearly visible in the lowest point on the blue line above).
Since the end of the 2008-2009 bear market, which turned around on March 9 of 2009, equity mutual funds have experienced less severe outflows of assets, and even a few months of positive inflows, but in general the net flows for equity funds have been almost all negative. The outflows have not crossed the forty billion line again, but they have often been greater than twenty billion going out per month. There were a few periods in which investors in the aggregate briefly added to equity funds, only to change their minds shortly thereafter and return to net withdrawals.
As Scott Grannis also points out in his post, inflows into bond funds over the same period since the 2008-2009 recession have been mostly positive, indicating that on the aggregate investors have been generally pulling money out of equity funds and into bond funds since 2008.
Unfortunately for investors, this exodus from "risky" equities into what are perceived as "safer" bonds is not necessarily a wise way to allocate assets. We have pointed out in the past that historical data from the 2000-2002 bear market indicates that investors in the aggregate were pulling money out of equity funds (and plowing money into bond funds) at the very bottom of the equity markets, just as they were piling money into equity funds at record rates just prior to the equity market collapse in 2000.
That post was published in September of 2008, as investors in the aggregate were selling equities at very bad prices. We continued to advise against panicked selling right up through the March 2009 market bottom (at a point when many who had hung on at the end of 2008 were losing their resolve and selling their shares). In fact, we were making portfolio acquisitions of well-run growth companies at that time, which would perform very well during the ensuing months and years.
More recently, we pointed out the exact same phenomenon discussed by Scott Grannis above in a post dated October 2010. At that time, we remarked that:
This kind of behavior is exactly what leads to the dismal long-term returns highlighted by numerous Dalbar studies year after year, which we have discussed in several previous posts. While many articles (such as the Times
article) focus on this as the behavior of the "small investor," it is
important to note that many of these small investors [individuals, regardless of wealth, as opposed to institutions] are in fact advised by professionals who
bear much of the blame.
The most recently-published 2012 Dalbar study confirms the same general pattern discussed in the link from that 2010 post, and seen in previous Dalbar studies stretching back to 1994. In that 2012 study, Dalbar found that the average equity mutual fund investor achieved a return of negative 5.73% in 2011, in spite of the fact that the overall equity markets as measured by the S&P 500 grew by a positive 2.12% that year. The same study found that the long-term results were equally dismal: for the twenty-year period ending in 2011, the average equity investor achieved an average annual return of 3.49%, while the markets as measured by the S&P 500 grew at an annualized rate of 7.81%.
As usual, the authors of the Dalbar study conclude that the kind of stock-market guessing indicated by the stock and bond inflow/outflow data we have been discussing above is a major factor contributing to the self-inflicted damage investors experience.
We have consistently declared that we cannot predict markets, neither the stock market nor the bond market, but that we believe that careful analysis and a disciplined process can uncover exceptional companies whose performance over long periods of time can be predicted to some degree. We advise our readers to focus on owning the securities issued by such businesses*, and to avoid the dangerous practice of trying to jump in and out of the stock market and/or the bond market.
* As an aside, we havewritten elsewhereabout our belief that investors should focus on individual businesses and the individual stocks or bonds issued by those individual companies, rather than investing in mutual funds (whether equity mutual funds or bond funds).
Well, it's a new year and the markets around the world today have been exuberant in their response to the application of the brakes at the last possible moment before hurtling over the so-called "fiscal cliff."
Some analysts have suggested that policymakers "played chicken" for so long before slamming on the brakes that the Senate, at least, could not possibly have even read the final agreement before they voted to approve it. But, no matter -- what the markets are happy about today is the fact that things probably could have been a whole lot worse, in that taxes will go up (more on that in a moment) but not by as much as they might have.
As many have also pointed out, and as we would like to point out as well, the last-minute "compromise" that moved through Congress was by no means a "budget." What the politicians in Washington hammered out was a tax package, and one that does not even pretend to address the elephant in the room, which is the need for spending cuts on the entitlements (Medicare and Social Security in particular) that in some future budget will have to be addressed (but just not yet). In the meantime, instead of dealing with that thorny issue, we have a bit of tinkering around the edges of the tax levels, and harmful tinkering at that.
The percentage of an employee's income taxed by the federal government for Social Security now reverts to 6.2% (from a temporarily-reduced level of 4.2%), which will immediately impact everyone drawing a paycheck in 2013. Individuals filing annual returns for 2013 showing an adjusted gross income (AGI) of $250,000 or more -- and couples filing jointly with an AGI of $300,000 or more -- will see many of their deductions reduced or eliminated, including the "personal exemption" as well as the elimination of the majority of itemized deductions available to such filers, including charitable contributions and mortgage interest.
Most significantly, the new cliff deal raises income and capital gains / dividend tax rates on individuals with a 2013 AGI of $400,000 or more, and on couples filing jointly with an AGI of $450,000 or more. Those taxpayers will see their marginal income tax rates rise to 39.6% from 35%, and their tax on any capital gains and dividends rise to 20% from the previous 15%. We have written before that these types of increased tax rates on investment, even if they are only enacted on "the wealthiest 2%" -- as the president described them in his press briefing minutes after the deal was reached -- can be very significant to the decision of whether to expand a business, fund a young entrepreneur with a promising innovation or new idea, or take a pass on risky investments because any increase will be taxed more heavily. In other words, the tax rates on "the wealthiest" matter to everyone, as we explained in that previous post.
On the other hand, the increases agreed upon in this last-minute deal are not likely to be devastating, and they certainly could have been worse in many ways (the levels of AGI at which the increased taxes on investment gains might have been set even lower, for instance). They will handicap the economy some more, to be sure, but they do not represent a reason for investors to panic or flee in terror. They are simply another canvas bag filled with birdshot that will now be padlocked to the necks of the citizenry and hence the economy as a whole, to use the vivid metaphor created by author Kurt Vonnegut in his 1961 short story, "Harrison Bergeron."
In that disturbing tale, set in a dark dystopian future in the year 2081, the "United States Handicapper General" mandates "handicap bags" to be worn at all times by anyone who is stronger than average, as well as a variety of other impediments to compensate for any above-average traits, including masks for those with beautiful faces, and ear implants that blast mentally-disruptive bursts of noise for anyone of above-average thinking ability. The story can be found in Vonnegut's collection of stories entitled Welcome to the Monkey House as well as in a variety of places on the internet (here is one website where you can read it; it is broken into two pages and the second page is here).
The fiscal cliff deal, in other words, only adds another "handicap" to the economy, along with all the others that the politicians (of both parties) have been mandating for decades, with greater or lesser degrees of negative impact (see our previous post entitled "We get by in spite" for more on that subject). As we have written before, during times (such as this one) in which the economy and climate for growth is more dystopian than normal, investors cannot rely on the idea that "a rising tide lifts all boats," and must become even more selective in the companies in which they invest their capital. Investors have to seek out truly exceptional destinations for their investment capital, in other words -- exceptional in the way that young Harrison Bergeron or the ballerina are exceptional, so to speak.
We wish all our readers a very Happy New Year, and welcome to 2081 2013!
