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Lipper: Investors have to tolerate less than complete perfection

The US election is likely to give way to excessive volatility, so get ready to roll with the punches, warns the Wall St. veteran.

Lipper: Investors have to tolerate less than complete perfection

Mistakes are common in all endeavours. That is why we should learn from them (and raise the fundamental question as to why we don’t). 

Some individual and institutional investors are unhappy with their portfolio results and are seeking to make small adjustments. There is, however, rarely an almost perfect portfolio than can be converted to complete satisfaction by the change of a single security or fund.

The crux of the problem is addressing multiple needs with a single solution. Most often investors have a diversified portfolio in mind, but due to an emotional need to be with the crowd their investment performance is closer to that of the popular indices.

Accepting that we will be wrong

True diversity can only be accomplished long-term by a collection of winners and losers at different points in time. In our everyday lives we are both self-insurers and hedgers, taking on physical risks at home and at work. While we may have fire and auto insurance policies, they are unlikely to pay off enough to totally substitute the new for the old. In effect we accept the shortfall as part of the bargain embedded in the contract.

In other words, we chose to tolerate less than complete perfection. Yet in our portfolios we wish to avoid any deficits in actual or relative returns. Understanding how the markets and life rotate disappointments and mistakes hopefully gives us the opportunity to own winners where the gains are much larger than the mistakes.

The so-called mistakes may quite possibly be insurance premiums to be activated in future periods. I therefore favour dividing a single portfolio into parts, first in terms of risks and second in terms of desired delivery time.

If one has only a single-view portfolio, then any ‘mistake’ is a negative. A portfolio that addresses different levels of risks or different time periods, however, provides some insurance.

Today’s risks include changing tax rates, materially higher inflation, fall of purchasing power due to currency changes, technological changes, management changes, political changes, medical and health conditions, and the unknowns.

Could this be the time to change?

One of the disadvantages in pouring over current data is that whatever occurred recently has little to do with what will occur subsequently. Nevertheless, the performance of equity-oriented mutual funds for the week ended last Thursday could be indicative of future directions. In contrast to the slight decline of -0.85% for the average S&P 500 Index fund, 87 fund peer groups did better.

The five peer groups averages that did best included: Base Metals Commodity Funds +2.49%, Latin American Funds +2.46%, Financial Services Funds +1.87%, Utilities Funds +1.58%, and Agricultural Funds +1.38%.

I know of not a single portfolio that holds all five weekly leaders. The only common denominator is that these groups underperformed the S&P 500 for a considerable period of time, as did most of the other 82 peer groups. 

This is not only a US phenomenon. Of 44 markets in local currencies, only 15 Ex-US markets gained, including 2 European markets (Moscow and Spain). In contrast to many of the pro-inflationary funds groups, the average 6-month money market deposit account interest rate declined to 0.19%, down from 0.22% the prior week and a three year high of 0.72%, signalling that many banks cannot find secure borrowers to lend to.

One additional symptom of a speculative market producing a lot of gains for some nervous holders is the change in trading volume on a year over year basis. NYSE listed stocks +7.84%, DJIA stocks +46.09%, NASDAQ +84.86% and Dow Jones Transport stocks +186.19%. Traders of volatile stocks are likely to look for future volatility.

Working conclusions

Clear investment answers are not likely to be revealed immediately after the US elections. I suspect we will be in for a period of excess volatility that will attract more cash off the sidelines. This uneasy period is not likely to end until most if not all the cash has been consumed.

While this frenetic period continues, there will be time to transform a single portfolio into a collection of portfolios based on different needs and risk appetites. All portfolios should have sufficient reserves to absorb the mistakes that will occur without hurting the investment objectives too much.

A former president of the New York Society for Security Analysts, Michael Lipper was president of Lipper Analytical Services Inc. the home of the global array of Lipper indexes, averages and performance analyses for mutual funds. His blog can be found here.

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