By Bill Kelly, CAIA CEO
According to the Gregorian Calendar today is Easter Monday. It is a holiday in many countries around the world and even for the non-celebrants, visual cues abound. In many regions the universal symbol is the decorated egg. While Hallmark may have made this into an industry, its roots can be traced back to the 13th century, where congregations abstained from eggs as a form of penance in the period leading up to Easter, when they could once again be consumed in all their decorative glory. Underneath the said glory of those intricate designs, three common things can always be found: a hard shell, an egg white, and a yellow yolk. A common product, in a single basket...
This Easter set-up is what is known as a “fat pitch” if you are in the business of dispensing common educational wisdom in the investment space. Diversification remains the only free lunch in the investment cafeteria and putting all of your eggs in that one basket has never proven to be a winning strategy. Products abound and the number of mutual funds and ETFs available around the world are measured in the tens of thousands. Like those colorful eggs, the wrappers look enticing, but it is what goes on inside the shell that matters. Often you might find very different fee structures, fancy product names, cute ticker symbols, and an ad campaign designed specifically to appeal to your softer side. The fear of missing out is a tremendous magnetic pull and our behavioral instincts often cause us to lose sight of the longer term and chase that shiniest and brightest egg in the grassy pasture rolling right out in front of us. If this sounds like most global equity markets post the GFC, you have grasped the analogy of that fat pitch and put it right over the wall in deep centerfield.
Gregorian Calendars and financial markets each have their cycles and not every day is a celebration. The CAIA Association, in the first quarter of 2018, began creating a model Alternative Asset Portfolio in our quarterly Alternative Investment Analyst Review where we compare this diversified index to a very wide range of asset class indices over short, medium and long-term horizons, accompanied by annualized volatility and max drawdown percentages.
The one-year winner (for the period ending September 2017) is the MSCI Emerging Markets Index clocking in at +23%; how wonderful to have had that in your basket this year! Perhaps, but if that was your only egg and you held it for ten years, you would have compounded your savings at a much leaner 2% per annum and would have had to hold tight during periods of 24% annual volatility, and a gut-wrenching drawdown of 53% during that ride.
What if you had spread those eggs across a wider set of baskets? Well, this Easter Stroll would not have won you any awards with our diversified Alternative Asset Portfolio which posted a more pedestrian 8% return, or just about one-third of the single basket hero. But look behind the numbers and you will find a very different story. Your nest egg would have compounded three times higher over 10 years with 70% less annual volatility and a substantially smaller maximum drawdown. Think about that as you peel the shiny shell off this year’s hard-boiled egg.
Seek diversification, education and know your risk tolerance. Investing is for the long term.