«John West: Why Most Capital-Market Assumptions are Unreasonable November 7, 2016 by Robert Huebscher John West is a managing director and head of ...»
I got in this business 21 years ago as an institutional investment consultant, which is someone who essentially does the same things that advisors do. My value-add proposition was asset allocation, manager selection and performance measurement. All of the factors you just mentioned mean that advisors really need to rethink how they can add value. Those that rely upon statements such as, “I’m a better asset allocator; I understand where the market is going more; I can pick better managers; I’m going to fire the managers before they get into performance trouble,” have to shift into understanding how to be a “long-term investor coach.” The vast majority of advisors have client time horizons that are at least 10 years. An 80-year-old has an eight-and-a-half-year life expectancy. Everybody has a 10-year time horizon. What truly drives asset class returns over such horizons? What truly drives strategy returns? How do we keep our clients from making poor choices about abandoning strategies or their risk profile at times of market crisis?
This is what I mean by the advisor shifting to more of an educator-coach role, rather than someone who is outsmarting the competition to give their clients better returns. Smart beta, factor investing, and the overwhelming victory we’ve seen index funds achieve over the last 10 years over active management all lead to a structural shift in how advisors interact with clients.
Will the shift be permanent?
Cap-weighted indexes have notably dominated active managers over two distinct long horizons in my 21 years, in the late 1990s and today. Both of those were periods when growth stocks massively outperformed value. Growth stocks have higher multiples and therefore higher market capitalizations.
Active managers tend to have their outperformance, cumulatively as a group, at periods when value and small size are winning. When growth and large mega caps are winning, active managers typically struggle.
Part of me wants to say this is cyclical in nature. But if people want to say value and small are going to Page 5, ©2016 Advisor Perspectives, Inc. All rights reserved.
come back, they can get that through factor and smart-beta strategies just as easily. I do think active managers will have a better run in the next five or 10 years than they had the last five or 10, but that doesn’t necessarily mean they’re going to get better flows. A lot of their traditional methods have been replicated by more systematic, lower-cost strategies.
What guidance are you offering relative to inflation hedging?
Inflation expectations have dropped from 2.5% on a 10-year basis to about 1.2% earlier this year.
That’s an approximate 50% decline in inflation expectations. Commodities, energy stocks, TIPS relative to Treasury bonds, emerging markets, emerging-market currencies and high-yield bonds have all tended to have a little higher correlation with changes to inflation, and have been savaged relative to mainstream stocks and bonds. A lot of advisors are asking, “Do I need a little bit of inflation protection?
It’s been so brutal to hold on to those types of strategies, but is now the time I should give up on them?” The greatest mistake I’ve seen in my 21 years in the industry was in the late 1990s when people used recent performance to dictate their diversification policies. They gave up on value, they gave up on inflation and diversifying strategies. A lot of advisors are struggling with how much they should put in to things that can do better in a reflationary environment versus what we’ve had, which is clearly a disinflationary environment for the last handful of years. If you go to our website and look at the strategies we think are likely poised to give you better returns, it’s all those strategies that have been left behind in this disinflationary cycle.
Don’t give up on your inflation hedges just yet. Fill and diversify a basket of them. They will be important at some point in the next five or 10 years.
Page 6, ©2016 Advisor Perspectives, Inc. All rights reserved.