Consensus forecasts, including our own, are for financial markets to offer below historical level market returns over the mid-term (next 5-7 years). This year has been an example of this theme with the S&P 500 up 3.4% and the Barclays Aggregate bond index up 0.68% through November 20th.
With this in mind, three thoughts on making money in a “sideways market”:
1. Collect your dividends and interest – Dividends and interest are an essential part of returns for investors. Currently, the S&P 500 dividend yield is 2%, the MSCI EAFE is 3% and the 10 year U.S. Treasury bond index is 2.2%. While all yields are below historical levels, in the case of equities, this still makes up 1/4 of the expected total return over the mid-term.
- For retirees, be mindful of strategies that exclude fixed income or significantly underweight bonds in a portfolio. Investing capital with the only return expectation of capital appreciation can be a risky proposition for the “safe” part of your portfolio.
- Be thoughtful with any investments that cause you to forgo your normal dividends with stock investments. For example, structured notes are an investment gaining in popularity for their “principal guarantees” in a down market. Keep in mind, there are no silver bullets with investing and there are always tradeoffs. In the case of structured notes, the tradeoffs typically include sacrificing any yield while in the investment, a maturity that is most likely 3-5 years out without daily liquidity at fair market value. Structured notes are also subject to the credit risk of the underlying issuer. Assuming a 5 year maturity for a note linked to the S&P 500, an investor is conceding 10% of total return the first day of the investment, assuming the dividend yield remains at 2%, for some promise of downside risk protection in 5 years if the index is lower.
2. Active management – Seek active management strategies that are favorable for certain asset classes. One strategy to consider within stocks is the use of Long/Short managers. Long/Short is an investing strategy of taking long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline. A Long/Short equity strategy seeks to minimize market exposure, while profiting from stock gains in the long positions and price declines in the short positions.
Given market volatility this year, we are seeing favorable conditions return for equity Long/Short managers.
How has equity Long/Short performed relative to the long-only markets? The table below shows sample equity Long/Short returns versus the MSCI AC World Index over rolling return periods and the percentage of periods equity Long/Short outperforms the index. While reliable data on hedge funds only goes back to 1994, it demonstrates a very clear picture of the risk-reward characteristics of equity Long/Short relative to the equity markets.
Due to the nature of compounding and the equity Long/Short strategy’s ability to mitigate losses in down periods, the strategy provides a more stable, consistent risk profile while generating higher returns over the long term through a variety of market environments.
Choosing equity Long/Short managers is no easy task as evidenced by the wide range of returns in the table above. To find managers capable of performing in the top quartile of the peer group requires extensive due diligence. The skills, knowledge and experience to complete this level of analysis are not typically found in most wealth management firms. This is a primary reason why our investment committee at Gryphon Financial Partners chooses to partner with HighTower and the Asset Consulting Group (ACG) given their depth of expertise, analytical ability and deep bench strength to evaluate managers. Another advantage of working with these two partners is the access they provide to managers given the scale of assets each firm is collectively overseeing, $30 Billion in the case of HighTower and $80 Billion for ACG.
3. Cut the fat! – Look for opportunities in your own personal budget to reduce and eliminate expenses. Saving money is just as good as making money! This process starts by completing a review of your past spending. For most, this can be a cumbersome project to collect checking account and monthly credit card statements. Technology has brought many options to streamline these efforts going forward once an initial investment to set up a system is made. If you are not tracking your expenses today, you might consider beginning as many find ways to eliminate spending with little to no impact on your quality of lifestyle.