This week, Morningstar held its annual Investment Conference. Attended primarily by financial advisers, the conference is notable for both its size and its mutual fund focus (though there were sessions on other topics). This week, I’ll share some of my notes and observations. You’ll see a few articles resulting from meetings I had at the conference in future issues of the AAII Journal.
One of the topics brought up was smart beta, or as Morningstar refers to it, strategic beta. These strategies emphasize certain risk factors (stock characteristics shown to have a return premium associated with them). Rob Arnott of Research Affiliates and Cliff Asness of AQR Capital Management both cited value and momentum as factors that lead to higher stock returns. Asness does not see value, momentum and low volatility as being “arbitraged away soon.” He wasn’t sure about profitability, but described it as being interesting enough to look at over the long term. Though associated with a lower risk premium, he thinks the profitability factor is uncorrelated with value.
Arnott thinks investors should check “the price tag” of what they are buying, since factors can become overvalued when too many people are using strategies based on the same risk factor. He observed that people tend to pile into what has worked recently and shift out of what has hurt them recently. Arnott described this pattern as a sign that even though investors know they should buy low and sell high, they don’t do it. Arnott then added that the essence of successful investing is fighting against human nature.
William “Bill” Bernstein of Efficient Frontier Advisors (and a well-published author) expressed a similar view during a different session. When asked about smart beta strategies, he quipped that the real danger is when smart beta meets dumb money. He also thinks investors will pile out of these types of funds at the wrong time.
Regarding the market and economic environment, Michael Hasenstab of Franklin Templeton Investments shared a few insights about the macro environment. He blamed a mismatch between skills and job openings for keeping unemployment high and creating wage pressure (fewer skilled workers for employers to fill positions with). He explained that while China is experiencing a slowdown in its manufacturing sector, its services sector is growing. In regard to the bond market, Hasenstab pointed to past periods of mispriced yields ending with bubbles.
A day before the Federal Open Market Committee released its updated forecasts, Austan Goolsbee—a former chairman of the Council of Economic Advisors—singled out the Federal Reserve’s forecasts of 12-month growth as having been wrong for years. He thinks the problem is that the committee views 2006 as representing normal growth, which would assume a new housing bubble. Goolsbee’s expectation is for the economy to continue “plodding along” over the foreseeable future. He tried to console the audience by paraphrasing Warren Buffett: Look at where the Dow Jones industrial average was in 1900, where it is now and think about everything that has gone wrong in between—wars, influenza, Justin Bieber….
An assumption of lower rates of returns has led David Blanchett of Morningstar to lower his projections for the likelihood of a retiree not outliving his savings over a 30-year period using a 4% withdrawal rate with a 50% stock/50% bond portfolio. Rather than having a success rate (likelihood of not running out of money) in excess of 90%, he thinks it is now a coin toss. The reason is a lower assumed rate of return. Blanchett cautioned the financial advisers in the audience not to assume that low returns will continue forever, however.
In the same session, Jonathan Guyton of Cornerstone Wealth Advisors suggested using bands to adjust withdrawal rates in response to market conditions. These bands would start at 20% above and below the initial withdrawal rate and move upward as the withdrawal rate is adjusted in response to inflation. If the withdrawal rate hits the upper band, withdrawals are reduced by 10%. If the lower band is hit, the withdrawal rate is increased by 10%. The upper band would be hit if your portfolio fell in value due to a period of bad market returns. The reduction in wealth increases the percentage of total assets a certain dollar amount of withdrawal accounts for, thereby causing the upper band to be hit. In response, you would reduce the size of your withdrawal amount. The reverse would occur during periods of good market conditions.
Finally, William (“Bill") McNabb, the CEO of Vanguard, shared a few interesting observations. He doesn’t see liquidity being an issue in the bond market despite newer regulations (e.g., Dodd-Frank) and lower inventories at dealers that facilitate trades. Vanguard is working on new “holistic” tools for advisers to help the growing number of retirees with portfolio withdrawals. The company is also working on building simplified computer interfaces to help retirees better manage the savings they have accumulated in retirement savings accounts such as 401(k) plans. Regarding fees, he said the firm is not done cutting them.
The Week Ahead
The Week Ahead
On Thursday, British voters will be asked “Should the United Kingdom remain a member of the European Union or leave the European Union?” BBC News has a good article explaining the upcoming Brexit referendum.
We’ll get our first glimpse at second-quarter results as a group of early reporters step up to the plate. Among them are S&P 500 members Adobe Systems (ADBE), CarMax (KMX), FedEx Corp. (FDX) and Lennar Corp. (LEN) on Tuesday; Bed Bath & Beyond (BBBY) and Red Hat (RHT) on Wednesday; and Accenture Plc (ACN) on Thursday.
The week’s first economic report will be May existing home sales, released on Wednesday. Thursday will feature the June Purchasing Managers’ Manufacturing Index (PMI) flash and May new home sales. May durable goods orders and June consumer sentiment will be released on Friday.
Two Federal Reserve officials will make public appearances: Chair Janet Yellen on Tuesday and Dallas president Robert Kaplan on Thursday.
The Treasury Department will auction $26 billion of two-year notes on Monday; $34 billion of five-year notes on Tuesday; and $13 billion of two-year floating rate notes (FRN), $28 billion of traditional seven-year notes and $5 billion of 30-year inflation-protected securities (TIPS) on Wednesday.
About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)
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