Content provided by Kostya Etus, CLS Portfolio Manager
At CLS, our focus on global markets and balanced portfolios has faced tough headwinds over the past year. But does that mean we should abandon ship? If we tossed our investment plans overboard every time the waters got rough (to stretch a metaphor here), we would be chasing performance. And if there’s one thing we know, basing investment decisions on performance-chasing instead of time-tested investment philosophies is the surest way to tank returns.
Global, balanced portfolios can provide a smoother ride for investors over time and a better, long-term experience. Here’s why:
A Global View
Historically, globally diversified portfolios have earned superior risk-adjusted returns, but recent underperformance has made investors wary. The inherent benefits of international diversification, however, have not changed. In fact, the argument for global investing is growing stronger.
While the U.S. still makes up the majority of the global market, international markets have grown over time and now account for nearly 47% of the total world market. Many countries are growing faster than the U.S., making them attractive places for investment allocation. Technological advances along with structural reforms have also opened up new investable markets and driven progress in many developing countries.
Checks and Balances
Diversification is the main benefit of balanced portfolios. Combining asset classes with low correlations tends to produce portfolios with lower volatilities. Portfolios with lower volatility (risk) typically lead to steady returns and eliminate short-term market noise.
One of the more overlooked benefits of diversification is that it saves investors from themselves. The natural human tendency is to buy winners and sell losers. This typically leads to buying at peaks and selling at troughs. Sticking to a balanced portfolio avoids some of these dangerous human behaviors, such as abandoning a long-term investment philosophy based on one-year returns.
The Threat of Us
To evaluate and quantify the human nature effect, we compared Morningstar’s investor return data, which compares the average investor’s returns in a fund over a period of time, to the total return for all U.S. mutual funds (over 20,000 funds with one-year performance and almost 13,000 funds with five-year performance). The results were fairly consistent across time periods. The investor return underperformed the total return by about 1%. That difference is known as the behavior gap, i.e., the cost associated with human behavior. Interestingly, the behavior gap was fairly consistent across all Morningstar categories. Thus it’s clear that no matter what people are investing in, they need to be saved from themselves.
Here at CLS, we’re not about chasing performance. And we’ll stick to what we believe works – global, balanced portfolios.