Asset Allocation & Risk
Risk Adjusted Asset Allocation
After years of volatile and sometimes fiercely downward markets, we believe a philosophy different from the conventional approach is required to produce meaningful investment results. The fad of the “gunslinger” led to heavy losses in 1969-1974, just as the fad of the “one decision” stock produced enormous losses in 1973-1974 as did the popping of the NASDAQ Tech bubble in 2000. “Buy and Hold” strategies have disappointed investors for a generation.
Since 1975, the performance results of many professional investment advisers and mutual funds have consistently trailed those of the broad market averages. To cope with such failures, the fad of “index funds” was developed, but indexing is actually an admission of defeat by money managers. They cannot do the job so they resign themselves to mirroring the action of the averages. In difficult markets like 2000 or 2008, indexing means accepting a loss with equanimity. DR&T does not believe that approach is sensible, desirable, or necessary.
Whenever investors lose money in a down market, they lose valuable time. If you analyze the years spent going through a bear market and then returning to break-even, you find that investors were actually making money only one-third of the time. The rest of those years were spent sitting out bear markets and the subsequent return to break-even.
The stock market has historically outperformed virtually all other investments, but at the cost of subjecting investors to greater volatility. Between 1929 and 2022 there have been 17 bear markets, defined as those periods where the S&P 500 has fallen at least 20%. The average bear market, slashed almost 39% from stock prices. Omit the ’29 crash, when values declined 87%, and the result is still an average loss of 33%.
S&P 500 Index Bear Market Study
|
Bear Market
|
Duration (months)
|
Decline (%)
|
Years to Break-even
|
|---|---|---|---|
|
Sept '29 - June '32
|
33
|
86.7
|
25.2 years
|
|
July '33 - Mar '36
|
20
|
33.9
|
2.3 years
|
|
Mar '37 - Mar '38
|
12
|
54.5
|
8.8 years
|
|
Nov '38 - April '42
|
41
|
45.4
|
6.4 years
|
|
May '46 - Mar '48
|
22
|
28.1
|
4.1 years
|
|
Aug '56 - Oct '5
|
14
|
21.6
|
2.1 years
|
|
Dec '61 - June '62
|
6
|
28
|
1.8 years
|
|
Feb '66 - Oct '66
|
8
|
22.2
|
1.4 years
|
|
Nov '68 - May '70
|
18
|
36.1
|
3.3 years
|
|
Jan '73 - Oct '74
|
21
|
48.2
|
7.6 years
|
|
Nov '80 - Aug '82
|
21
|
27.1
|
2.1 years
|
|
Aug '87 - Dec '87
|
4
|
33.5
|
1.9 years
|
|
July '90 - Oct '90
|
3
|
19.9
|
0.6 years
|
|
Mar '00 - Oct '02
|
31
|
49.2
|
7.2 years
|
|
Oct '07 - Mar '09
|
17
|
56.6
|
4.5 years
|
During that 92-year period, a new bear market began every five years, with an average duration of 18 months. After the bear market bottomed, omitting the distortion of the 1929 crash, it took an average of 3.9 years just to return to a break-even position. Every time investors lose money in a down market, they lose valuable time. If an average bear market reduces the value of your portfolio by 25%, you need a 33% return to return to break-even.
After eliminating overlapping bear markets, 50 years were spent either suffering through a bear market or returning to break-even. In other words, investors spent 2/3 of their time just trying to stay even. Only 1/3 of the times were they benefiting from the stock market’s ability to make their investments grow in value.
Many individuals and institutions have chosen to forego the superior performance of the stock market because they are unable or afraid to invest solely for the long term or take the risk of sudden short-term losses. For these investors, dynamic asset allocation offers the opportunity to participate in the market with the goal of reducing risk and increasing risk-adjusted returns.
When risk is figured into their returns, studies have shown that skilled asset allocators consistently outperform the market. According to a study published in the Journal of Portfolio Management in the summer of 1992, 92% of the 25 allocators tracked by MoniResearch Newsletter outperformed the market averages in the 1987 collapse, as did 96% during the drop in June 1990.
As seasoned investors in bear markets, we know how to protect capital and we respect the risk inherent in business and financial cycles.