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Lessons from the Zeroes (2000-2009)

Gary Karz, CFA (email)
Host of InvestorHome
Principal, Proficient Investment Management, LLC

     The first decade of the new millennium was certainly eventful to say the least. Unfortunately for many US equity investors it was less than rewarding. It was especially sobering for many in light of some of the widely publicized prognostications at the start of the millennium. Looking back to 1999, Professor Jeremy Siegel's Stocks for the Long Run (1998) had reached the masses (penetrating a much larger audience than Ibbotson's annually published Stocks, Bonds, Bills, and Inflation Yearbook). Given the historical evidence, there was much debate about whether long term investors should be 100% invested in stocks. Many institutional and high net worth investors were debating how much to allocate to Hedge Funds. On the InvestorHome Bulls & Bears page (which I neglected to update since 2000) I had recorded predictions for the DJIA from well known investment authors that included

     If we had known in advance that the continental United States would be attacked, subsequently wage two wars, and then the world would experience a near collapse of the financial system near the end of the decade, we possibly would have seen less optimistic projections for investment returns.

     Nonetheless, we ended the decade with equity returns ironically in-line with one of the decades nicknames - zeros. The Wilshire 5000 was down slightly while most equity mutual funds were also close to zero (and certainly below inflation for the vast majority of equity investors). Yale Professor William Goetzmann noted in MarketWatch's Year end review that 12/31/09 marked the end of what was the worst calendar decade for stocks since the 1820s, when reliable stock-market records began.

     According to the International Monetary Fund, the US began the century producing 32 percent of the world's gross domestic product, but ended the decade producing 24 percent. Pat Buchanon's wrote in A Decade of Self-Delusion that no nation in modern history, save for the late Soviet Union, has seen so precipitous a decline in relative power in a single decade ... The United States began the century with a budget surplus, but ended with a deficit of 10 percent of gross domestic product (to be repeated in 2010). Where the economy was at full employment in 2000, roughly 10 percent of the labor force is now out of work and another 7 percent is underemployed or has given up looking for a job. While the median income of American families was stagnant, the national debt doubled.

     P&I noted it was a great decade for Bonds - Over the past 10 years, bonds returned more than equities and hedge funds, with significantly lower volatility. Yet investors have other factors to consider. We have substantial evidence (via Professor Ilia D. Dichev, Jason Zweig, and others) that actual investor returns are significantly lower than value weighted (buy-and-hold) returns assumed in the standard benchmark calculations. Investors tend to increase equity investment prior to periods of lower returns and decrease equity investments prior to stronger return periods (See What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns). Plus, for taxable accounts there is an additional issue to consider. A 2009 Lipper study found that buy-and-hold investors with mutual funds in a taxable account surrendered between 1.13% to 2.13% of their annual returns over the past 10 years.

     So what are the lessons of the decade? Here is my take.

  1. Assuming the US historical rate of return will predict future returns is clearly a precarious assumption, even if you have a decade to invest.
    One of the articles listed on the Investor Home Historical data page for the entire decade was "History, as written by the winners" in Forbes (6/16/97). That link is no longer active, but it was based largely on the work of William Goetzmann and Philippe Jorion, which you can read at SSRN - A Century of Global Stock Markets (1996) version. A fresher version is here where they summarize (which unfortunately turned out to be quite predictive of events) "estimates of return on capital are subject to survivorship, as the United States is arguably the most successful capitalist system in the world; most other countries have been plagued by political upheaval, war, and financial crises ... The high return premium obtained for U.S. equities therefore appears to be the exception rather than the rule."
  2. The arguments for diversification, efficient asset allocation, and modern portfolio theory should continue to grow in importance.
    Most investors with 100% stock allocations likely had little or no return to show for the decade (especially after considering inflation and taxes). Hedge funds (that survived) were all over the map, some making ridiculously large returns, but most underperfoming. Investors that included Bonds, Real Estate and International Stocks (and Emerging Markets in particular) in their portfolios, generally had higher returns with less risk.
  3. Investment costs are a critical (and often overlooked) negative component of results.
    In a lower return scenario costs absorb a larger percentage of returns and therefore should be focused on to an even greater degree than in the past. Investors need to evaluate their costs and preferably minimize them to increase their returns. For a large percentage of investors over the last decade, their advisors and investment firms made more from their investments than they did. Worse yet, many investors had negative returns, yet had to pay their advisors and firms adding to the losses.

    "I've run the numbers, and if you pay your broker 3% a year in commissions and fees, after about 24 years, they wind up with more of your assets than you have. Frightening."
    William Bernstein

Links and references

  • Wall Street Journal decade/year/quarter end links
  • Pensions & Investments
    • Charts
    • Hedge funds have best year since 1999 - The HFRI Fund Weighted Composite index returned 20.04% for the year (highest since the 31.29% return of the index in 1999). Index provider Hennessee Group also reported a strong 2009 return – 24.6% — for the Hennessee Hedge Fund index. Both hedge fund indexes were buoyed by 2009’s substantial equity rally, but trailed the calendar year returns of 26.5% for the S&P 500 index and 35.14% for the MSCI World index. By contrast, the Barclays Capital Aggregate Bond index returned 5.93% for the 12 months ended Dec. 31. Collective performance of hedge funds of funds last year trailed that of single manager hedge funds by nearly 900 basis points. The HFRI Funds of Funds Composite index returned 11.16% for the year ended Dec. 31, which while lower than that of the hedge fund composite index still a marked improvement on the 2008 return of -21.37%.
    • Private equity performance trumps venture cap - U.S. private equity returned 5.9% internal rate of return in the fourth quarter, 13.8% for 2009 and an annualized 7.8% for the 10 years ended Dec. 31, according to Cambridge Associates. U.S. buyouts returned 14.8% for the year, up from -22.7% for the year ended Dec. 31, 2008. Venture capital’s return was 3% for the year, up from -16.4% for the year ended Dec. 31, 2008.
  • FT Decade Review, Graphics
  • Callan periodic Table of annual returns for the last 20 years
  • CNN Money In 2009, the S&P 500 gained 23.4%, the Dow industrials gained 18.8% and the Nasdaq added 44%. 1Q10 - The Dow climbed 4.1% over the first three months of the year, while the S&P added 4.9% for the quarter. Stocks dive as second quarter ends.
  • Morningstar
  • Bloomberg's
  • Costs matter: Are fund investors voting with their feet? from Vanguard (May 2010). For the decade ending 12/31/09 funds with lower expense ratios received the lion’s share of investor dollars. According to a study by Cerulli Associates (2010), slightly more than half of the advisors surveyed had more than 50% of their clients’ assets in fee-based programs. And the expectation of continued advisor migration to fee-based accounts was cited as a “major driver” of future growth by asset managers. Such financial intermediaries seem to be increasingly directing their clients away from higher-cost funds and individual securities to lower-cost funds and exchange-traded vehicles
  • Short-Term and Long-Term Stock Market Index Returns from Eric Tyson (4/30/10)
  • 50 worst rolling 10 year returns from O'Shaughnessy
  • Why Stocks Beat Bonds (4/2010) by Jeremy Siegel and Emerging Markets Hit the Big Time from Kiplinger (4/2010)
  • Richard Ferri's decade review in Forbes includes some great commentary including
    • Time magazine labeled it the "Decade from Hell"
    • Bloomberg BusinessWeek called it "A Decade of Decay".
    • The Wall Street Journal is referring to it as the "Lost Decade."
    • CNN just calls it "ugly".
    • A simple portfolio of Vanguard Index funds would have returned 4.2% (versus 2.6% for the CPI) with 10 year track records (VBMFX) 40% at 6.1%, (VTSMX) 36% at -0.3%, (VGTSX) 18% at 2.3%, and (VGSIX) 6% at 10.4%.
  • It Wasn't a Lost Decade for Everyone by Howard R. Gold at MoneyShow 1/28/2010
  • A pretty good prediction came from bestselling author William Berstein in A Neurologist with the Nerve to Call His Own Investing Shots in BusinessWeek July 1999. "I believe that the large difference that we've seen between stock and bond returns over the past 70 years is not going to repeat itself. If you look at almost any kind of valuation model, it tells you that the returns on bonds are going to be higher than they have been in the past and the return on stocks smaller than they have in the past. I don't believe that you're going to see the return advantage on an all-stock portfolio that you saw in the past. I think that the loss of return you have by putting 40% of your allocation in bonds will not be that great, and you'll be greatly rewarded by your reduction in risk and your returns on bonds may actually be higher than stocks over the next 10 or 20 years.
  • Jeremy Grantham's ten year predictions in 1999 were also of note. See GMO's Review. Again on the point about investment costs, see Page 7. "Let’s start with the Investment Industry component. It is so obvious in this business that it’s a zero sum game. We collectively add nothing but costs. We produce no widgets; we merely shuffle the existing value of all stocks and all bonds in a cosmic poker game. At the end of each year, the investment community is behind the markets in total by about 1% costs and individuals by 2%. And the costs have steadily grown. As our industry’s assets grew tenfold from 1989 to 2007, despite huge economics of scale, the fees per dollar also grew. There was no fee competition, contrary to theory. Why? Clients can’t easily distinguish talent from luck or risk taking.
  • What a Difference a Decade Makes by John Creswell in Barron's 5/10/10
  • Happy anniversary? from Pensions & Investments - U.S. stocks mark 10 years of negative returns. From March 24, 2000, when the Wilshire 5000 reached its then-peak of 14,751.64, through March 23. 2010, when it closed at 12,287.44, the index produced an annualized -0.32% total return, including dividends reinvested. The cumulative total return was -3.11%. “In those 10 years we've had two bear markets and two bull markets, if you count the current run-up,” said Bob Waid, managing director and head of Wilshire index research, who produced the analysis. Overall, the analysis “shows diversification is good, across asset classes and within asset classes,” Mr. Waid said. The market results “reinforced” an allocation policy of a well-diversified, prudent pension plan, he added.

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