I try not to bore my readers with “inside baseball” in either this blog or our other communications. I assume that the details and arcana of our investment management process is mostly of interest only to dweebs like me and the other members of our Investment Committee. Our clients pay us to deliver results, not academic dissertations full of complex graphs and terms like beta, kurtosis or downside capture ratio.
But I worry that my desire to avoid jargon and spare you much of the technical detail that engages my attention sometimes causes me to miss “the bleeding obvious.” I had one of those “ah-ha” moments just last week. I was at a conference in Chicago, where the presenter asked the question, “What is the most important problem that your clients rely on you to help them solve?”
What instantly came to my mind was, “low investment returns.”
We always try to keep our focus on our clients and not on ourselves. For the last year or two, we have been talking a lot about the importance of our clients’ good financial habits – their high savings rates and responsible spending patterns. We like and admire our clients. When we draw those connections between their good habits and their financial security, we believe we are highlighting something vital.
But I worry that, in stressing so heavily our clients’ role in maintaining their own financial security, we may have created the false impression that we are carelessly confident about the market environment, despite a surplus of bad news and severe volatility. That is absolutely, categorically not the case. So a few words about what we think is going on, what worries us, and what we are doing about it.
We are neither predicting nor discounting the possibility of another financial crisis or market crash. We are not in the business of short-term market predictions. We can’t time the market, nor can the clowns on CNBC. (Don’t get me started about Jim Cramer.) Frankly, this market environment is challenging enough without agonizing about another crash that may or may not occur.
Our primary focus is always on the relationship between current prices and long-term return potential. Right now our numbers suggest that the stock market is trading on the high side of fair value, and we believe the economy is likely to grow below potential for years. The result: long-term investment returns on stocks in the low-to-mid single-digit range. (We are projecting 4% to 7%.) Meanwhile, returns on cash are zero, near enough. Ten-year Treasury bond yields are below 2%. If rates rise, bonds will get shellacked. There simply are not any hidden values in obscure asset classes that promise double-digit returns.
To borrow a phrase from military aviation, this is a “target-poor” environment.
Given the very real possibility of an extended sideways market, we are relentlessly, obsessively focused on what we can do to enhance returns. I think about this issue all the time, worry about it, even lose sleep over it. (And I am normally a very even-tempered guy.)
We have a phrase in our practice that we use to remind ourselves of what we owe our clients: “It is our responsibility to get their stuff done.” Part of what we need to “get it done” for our clients is positive investment returns. In my thirty-year career, earning returns sufficient to fund the accumulation of wealth, or to support cash flow in retirement, has never been more challenging.
Hence my lost sleep.
We don’t have any easy answers to the fundamental problem of sideways markets and low structural returns. That doesn’t mean we have lost confidence in our own abilities as investors. We believe our track record speaks for itself. But it does mean that we have put aside any slightest shred of complacency.
Right now we believe we have some real traction on where we will find opportunities to earn higher long-term returns. Short-term, we expect the market to continue to be volatile and unpredictable. The volatility that scares investors is likely to be the primary source of the opportunities we need if we are to enhance returns. This means the fundamental tension between investment opportunity and psychological comfort will be at the center of most portfolio decisions.
I plan to address these issues in more detail in the coming weeks. In the meantime, we hope this blog can provide an opportunity for more active dialogue. We have opened up the comments section, and I look forward to learning about what keeps you up at night, and how we can help.