The media and investors continue to obsess about the timing and extent of rate hikes.
Most research I’ve seen suggests that the market overall is still in good shape at the onset of a tightening cycle and that the more volatile period for equities is after tightening is completed.
As David Rosenberg of Gluskin Sheff stated in his May 29 comment, “the bull was gored only after the Fed took the funds rate from 1% to 5.25% from the summer of 2004 to the summer of 2006…..the real problems occurred following the last rate hike, not the first one, as is typical, cycle after cycle.”
Active Management
Forbes columnist Ken Fisher recently wrote: “Whatever you read lots about is surely priced in and easily ignored.” I couldn’t agree more.
Barron’s January 12, 2015 cover story “Return of the Stockpickers” argued that a rising interest rate environment would favor active management.
The article cited a study by Nomura Securities, which analyzed the period 1962 to 1981 when the 10-year note yield tripled.
The study’s finding: “The median cumulative return for large company mutual funds was 62% better than the S&P 500.”
Chance to Outperform
I have no idea if either of those will happen again. But now that the market has tripled from its 2009 low I think things will settle down a bit and active managers will have a better chance to outperform.
As Barron’s noted in its story, more than a quarter of the Russell 2,500 companies had negative net income in 2014. Owning those kinds of names is not a formula for long -erm investing success.
Broadly speaking, most clients want to participate in up markets and preserve capital in down markets. In other words, for most clients, beating an index is not the goal.
Yale Strategy
As I see it, the best answer to “how to outperform an index” I know of was provided by David Swenson, Yale’s Chief Investment Officer.
According to him, managers need to:
- Know the overall environment
- Run concentrated portfolios
- Do extensive research on investments so as to know when a sell off is a buying opportunity
- Have patience
- Be willing to deviate from the index
Most professional money managers are unable or unwilling to do all these as far as I can tell.
Photo Credit: Josep Ma. Rosell via Flickr Creative Commons
