mr bernstein

Strategies: In Investing, at Least, It Makes Sense to Play for a Tie

Frank Deford, the sportswriter, has drawn another conclusion about our national preferences: Americans don’t like losing, but what we really can’t stomach is a tie.

In a tongue-in-cheek radio commentary, he noted the oft-repeated observation that “a tie is like kissing your sister,” adding that “if there is one thing the red states and blue states can agree on, it is that.”

In 1996, college football eliminated ties, and the National Hockey League banished them in 2004. Ties are still frequent in soccer — but that may explain why that beautiful game is more beloved abroad than in the United States. Our distaste for ties, Mr. Deford says, “is one thing that sets us sons of liberty apart from most of the rest of the world.”

Playing for a tie may go against the grain of most American sports, but it should be central in investing. That’s because a core finding of modern finance theory is that we don’t need to beat the market. In fact, for most of us, once we’ve decided how much risk we want to bear, a better approach is aiming to tie — or match — the market return.

That’s the message of William J. Bernstein, an investment adviser and author, most recently, of the e-book, “Skating Where the Puck Was.” Periodically, Mr. Bernstein says, some investment manager discovers a way to generate outsize returns. Whether the favored asset class is Internet shares or gold bullion or oil futures or mortgage-backed securities, the new market-beater isn’t likely to last.

“As soon as one gets discovered, it’s already gone,” he writes. Matching the market is the best that most of us should hope to do.

Much the same insight appears in new research by two finance professors, R. David McLean of the University of Alberta and the Massachusetts Institute of Technology, and Jeffrey Pontiff of Boston College. The professors analyzed 82 academic studies that came up with ways of outperforming the market.

In their paper, they found that as soon as these methods were published, their efficacy began to decay, probably because other investors soon copied them. The paper, available online, is titled “Does Academic Research Destroy Stock Return Predictability?”

In an interview, Professor McLean said, “After publication of a paper about an investing strategy, on average, the performance of that strategy decayed by 35 percent.”

The professors didn’t assess the actual costs of putting any of these strategies into effect, but it’s likely that the costs outweigh the benefits for individual investors. “I doubt that it would make sense for most people to try them at home,” Professor McLean said.

And Professor Pontiff added, “I tell my own students that the core of their own personal investments probably ought to be a low-cost index fund that mirrors the market.”

IN his e-book, Mr. Bernstein acknowledges that some talented people do manage to beat the market, at least for a while. Some move ahead of the pack by discerning opportunities on a new financial frontier. But such vision is rare and such opportunities are fleeting. “It does happen, and people try to copy them, and that’s the problem,” he said in an interview.

In his book, he cites the late Sir John Templeton, who started a mutual fund, Templeton Growth, that was among the first in the United States to invest extensively abroad. In 1970, Mr. Bernstein says, Japanese stocks constituted 60 percent of the fund, and it performed splendidly. But as other foreign investors bought Japanese shares, and as global market performance became more correlated, that outperformance faded, Mr. Bernstein says. (Mr. Templeton was adept enough to shift the fund’s focus and find other opportunities.)

Similarly, Mr. Bernstein says, David Swensen, manager of the Yale endowment, took the “radical” step in the 1980s of moving more than half of the endowment’s assets into alternative asset classes like hedge funds, private equity, real estate and commodity futures.

Mr. Swensen was way ahead of most investors, and his strategy worked brilliantly, Mr. Bernstein writes. From July 1987 to June 2007, Mr. Swensen’s annualized return was 15.6 percent, Mr. Bernstein says, 4.8 percentage points higher than the Standard Poor’s 500-stock index. “Better yet, along the way, the endowment experienced considerably less volatility,” the author adds.

Mr. Swensen’s unusually strong record inspired copycats. The Yale model spread throughout university endowments and public and corporate pension funds, and nearly everyone tried to beat the performance of everyone else. The results were all too predictable, Mr. Bernstein says.

“As a dismal but useful rule, most good investment ideas eventually get run into the ground,” he writes. Lately, the performance of university endowments, including Yale’s, has been less impressive. Over the three- and five-year periods that ended in mid-2011, he says, a simple balanced index fund portfolio, 60 percent in stocks and 40 percent in bonds, beat the average university endowment. And putting money in the balanced index fund requires no skill and minimal fees.

The alternative approach — trying to duplicate the experience of a pioneer — is where Mr. Bernstein’s book title comes in. Copying exceptional strategies is like “skating where the puck was,” he says. As Wayne Gretzky, the hockey great, was taught by his father back when the N.H.L. still had ties, it’s better to skate where the puck will be.

That’s hard to do, though, and very risky. Mr. Bernstein, a retired neurologist based in Portland, Ore., says it’s better to play for a tie by assessing how much risk you are able to bear, allocating the assets in your portfolio carefully and using low-cost index funds to match the market’s returns.

Professor McLean adds that even if you identify a market anomaly that suggests a profitable strategy — overweighting small-cap value stocks, for example — you might use low-cost index funds in that category to exploit it. Match the performance of these market sectors, he says. You don’t need to take on extra risk by trying to beat them.

That’s why the metaphor for this approach may come from soccer, after all: sometimes the smartest strategy is just playing for a tie.

Article source: http://www.nytimes.com/2013/01/13/your-money/in-investing-at-least-it-makes-sense-to-play-for-a-tie.html?partner=rss&emc=rss

Strategies: Greek Bonds May Offer Contrarian Clues to U.S. Stocks

“You’ve got to keep your eyes on Greece, if for no other reason than that everyone else is,” said Richard Bernstein, formerly the chief investment strategist at Merrill Lynch and now the proprietor of his own firm and a fund manager for Eaton Vance.

Mr. Bernstein says his main focus right now is actually American stocks, which he favors for fundamental reasons: they are relatively cheap, he says, given the earnings they are likely to produce over the next decade. But for the short term, those virtues are often being overlooked by investors, so as a guidepost for Wall Street he has been looking at an unlikely benchmark, the Greek 10-year note.

It has had little intrinsic connection to the American stock market in the past, as Mr. Bernstein is quick to acknowledge. But it has been a perversely contrarian signal of late. As the European rescue plan for Greece appeared at times to unravel last week, Greek 10-year notes hit new lows, falling to less than 30 percent of their nominal value — a 70 percent discount. As the price dropped, the American stock market often rose.

“A decade ago, you’d have thought I was crazy if I told you there was a connection” between American equities and the fixed-income market in Greece, Mr. Bernstein says. Recently, though, there does seem to have been at least a loose correlation, he says, because American banks, both directly and indirectly, are exposed to the debt of Greece and other troubled European countries.

And the ups and downs of the Greek crisis have provided the impetus for the risk-on, risk-off trading that has dominated financial markets worldwide.

Quite often these days, the tone on Wall Street has been set by the frantic efforts to stave off a financial calamity in Europe. The uncertainty has been buffeting the American economy as well, as Ben S. Bernanke, the chairman of the Federal Reserve, said last week.

“Most notably,” Mr. Bernanke said, “concerns about European fiscal and banking issues have contributed to strains in global financial markets, which are likely to have adverse effects on confidence and growth.” He added that the Fed remained ready to intervene further, if needed.

Despite these problems, Mr. Bernstein says, investors should be focusing on the handsome profits that American companies are churning out. But he says it’s understandable that people are fixated on the immediate crisis in Greece. So he turns to the Greek bond as a back-of-the-envelope indicator. What’s his logic?

As he sees it, the sinking market price for those bonds tells him that the Greek bailout deal, if it holds together, will be extremely “bullish short term for banks,” and therefore “bullish short term for the stock market in the United States, too.” But in the slightly longer term, however, it will also be bearish for both. Why?

A “voluntary” 50 percent haircut — or discount — for those bonds was part of the fragile settlement worked out by European leaders late last month. The current market price amounts to a much higher de facto discount of about 70 percent, so if the European settlement holds, it will be a “very good deal” for bond holders — that is, banks, he said — and bank shares have often dominated the American stock market.

Slightly longer term, though, the pricing discrepancy implies that the European deal does not adequately account for the reduced value of Greek debt.

“Ultimately, the markets will be skeptical about any deal like this, because the debt has not been written down sufficiently,” he says. “It’s bearish longer term because it suggests that this crisis isn’t close to being over.”

Because prospects for a short-term settlement of the crisis grew shakier in the last week, he says, the implications of the sinking Greek bond may not be translatable into anything more than extreme volatility for global markets. He says the festering European crisis will probably make American stock markets “quite volatile” for some time, despite what he considers excellent prospects for American companies.

For fixed-income investors, meanwhile, the prospects are likewise not entirely positive, in the view of Kathy A. Jones, fixed-income strategist at Charles Schwab. The Fed “will be keeping interest rates very low for some time to come” on government bonds, she says. And in response to an economic slowdown and to the financial crisis in Europe, the European Central Bank lowered interest rates last week.

This environment, she says, “creates real dilemmas for individual investors,” who will need to decide whether to accept these rates or take on additional credit risk in an effort to get higher yields.

“Unfortunately, there are no easy solutions,” she said.

Scott Minerd, chief investment officer at Guggenheim Partners, says he believes that Treasury yields have already bottomed and are beginning to edge upward. The 10-year Treasury note is likely to breach 3 percent by the end of the quarter, he says, though he observes that the Fed appears to be “preparing the way” for further unorthodox policies aimed at keeping rates low and stimulating the economy.

He believes that it makes sense to buy some high-yield bonds. “The market for these securities got hammered so hard in anticipation of recession” that the prices are very attractive, he says.

Like Mr. Bernstein, Mr. Minerd is bullish on American stocks. He says he believes that the economy will muddle along, “and that it will actually turn out to perform better than the market has anticipated,” driving stocks higher.

Still, high volatility is part of his outlook, too, in large part because of the crisis in Europe.

“We’ve reached a stage where we all understand that a train wreck of some sort is coming,” he says. “The question is what will the wreck actually look like, how much damage will it do, and the markets have already priced in a lot of damage.”

As far as the Greek crisis goes, he says, there appears to be worse to come, though it may not be as bad as the market anticipates.

Article source: http://feeds.nytimes.com/click.phdo?i=a628cbc9bd370dbfcc8fda2e6263ffcc

Strategies: In Investing, at Least, It Makes Sense to Play for a Tie

Strategies: Greek Bonds May Offer Contrarian Clues to U.S. Stocks

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