Should the thought of riding a roller coaster or bungee jumping make you nervous — if not a bit nauseous — maybe the following can offer some relief. Let’s review what kind of damage the equity markets have wrought over the last year or so. You do not need to be a Nortel investor to have felt the impact of what have been the worst stock markets in the last 30 years. While there have been few places to hide from the onslaught of depressed prices, there have also been notable exceptions to what I call 3M (Massacre of the Millennium Markets). These are:
, Asset Classes such as income producing real estate, energy trusts, mortgages and bonds
, Equity Managers who practice a value approach to security selection
Before we examine the winners, let’s review the state of equity markets today. Table 1 shows 12 countries or regions and how much the index of that area has dropped from its peak.
Other “real” economy observations would include the following:
, While the US Federal Reserve has dropped interest rates seven times, there has been no discernible impact in either the equity markets or the economy at large.
, We are likely to see more bad news in areas such as employment, government surpluses and GDP before things turn around.
, Many markets (including the S&P 500 and the NASDAQ 100) are still trading at relatively high P/E multiples. However, bargains remain hard to find.
These markets have, in my opinion, proved two very old adages:
, You get what you pay for and
, Don’t put all of your eggs in one basket.
In less dated terms — to consistently make money, you must be well diversified among several asset classes and you need to be willing to pay for both the good advice and the good choices that a “value manager” will make.
There has been much written about the benefits one can receive through index investing. Essentially, the argument is that most active equity managers do not beat an index that represents their asset class. Since you can buy an index (or index fund) for a very low cost (usually less then 1% per year), you can make a single decision for your investment by buying a few indices, leaving you at ease concerning your portfolio’s status.
Over the long term, it is true that less than half of active managers beat a relevant index after their fees (the Canadian markets being an exception to that rule). That, however, should not come as any surprise. In Canada alone there are several hundred funds for the major asset classes such as Canadian, U.S. and Global equities. You would expect the average manager to do no better than the index before fees and a little worse after the fees.
We look for managers who are both value oriented and have proven, long term track records. In doing so, the odds of beating an index with less volatility are quite high.
The following two tables illustrate this point. The first shows how many equity managers were able to outperform the index in their asset category. The second shows the performance of several well known value equity managers in Canadian, U.S. and Global funds over both one and three year periods vs. the relevant index.
Table 2 shows that for, at least US and Global equities, the indices performance is better than the average manager, but that is not the case for Canadian equity indexes.
If one picks mutual fund managers at random, with little thought given to factors such as investment style, long term performance and volatility, then an index is probably a better choice. Nevertheless, as the chart below shows, there are many top managers who can invest your money and earn good returns independent of market conditions.
Each of the above funds charge considerably more than the cost of a comparable index. But clearly, they are creating results worth the price.
A few months ago, we wrote to you about assets that generate strong cash flow in the article Cash Flow is King. Those asset classes have done extremely well over the last three years and are a cornerstone of any balanced approach to investing. If those assets are combined with effective tax strategies and the kind of managers described above, you can weather this financial storm. If you choose a diversified value approach and are willing to pay for informed and dependable advice, then good results are inevitable. DPM
John Nicola is the president of Nicola Financial Group in Vancouver, BC. The company specializes in financial planning for professionals. He is a frequent lecturer at dental conferences and study programs.
