“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greats rewards.” Roger Gibson quoting Sir John M. Templeton
On April 23rd, Roger Gibson, CFA®, CFP®, spoke with FJY clients and friends on the topic of Multiple Asset Class Investing. Gibson is a well-known author and financial advisor and an internationally recognized expert in asset allocation and portfolio design. He is the Chief Investment Officer of Gibson Capital Management, Ltd. and author of the book, Asset Allocation: Balancing Financial Risk. Much of the conversation was focused on what Gibson believes are the four key determinants of portfolio performance.
An appropriate asset allocation is the foundation of any sound investment strategy. The selection of asset classes and the allocation of investments across the varying asset classes is a primary determinant of performance. The principle of diversification argues that combining asset classes that have low correlations (i.e., they act differently from one another) will result in a portfolio that has increased returns with lower volatility. After 2008, we see that the relationship among the different asset classes remains the same, yet the returns decreased and volatility increased. In other words, we have taken on more risk for less reward. Gibson believes that the benefits derived from asset allocation are not skill dependent, but are rather a function of how the asset classes work together.
Skill is the second determinant of portfolio performance; however, it is rare and difficult to identify. In order to successfully time the market or select stocks, one must have a disciplined due diligence process. This active management of portfolios increases expenses, and Gibson argues that with a good allocation strategy, skills-based management is unnecessary. When you begin to deploy market timing and specific security selection, higher expenses diminish returns and the portfolio is relying on the skill of an individual rather than a disciplined approach.
Asset location is also an important piece of portfolio performance. The positioning of certain tax-inefficient investments within tax-deferred accounts can greatly improve the portfolio’s after-tax returns. Of course, an investor’s ability to achieve tax efficiency is dependent upon the availability of investment funds in tax-sheltered accounts.
Investor behavior is the last, and arguably the most important, determinant of portfolio performance. The actions people take and the choices they make have much to do with their long term success as an investor. The efficient market hypothesis argues that investors use the information available and behave rationally given any market condition. Yet, we all understand that we use emotional as well as cognitive resources to make decisions. From 1984 to 2000, the average stock fund return was 14.0%, yet the average stock fund investor received an average annual return of only 5.3%…an 8.7% difference. A main contributor to this variance is that investors are often inclined to chase yesterday’s winners and do not have the skill to consistently predict tomorrow’s outperformer. Gibson argues that when pressure mounts to abandon a strategy, the advisor’s most important role is to encourage the investor to maintain discipline and stay the course.
In a year like 2008, many investors were faced with a difficult choice regarding whether to abandon their strategy. An appropriate risk tolerance is a key driver in whether investors overcame that challenge. Gibson addressed the potential reasons for re-evaluating risk tolerance, including one’s willingness to sustain further losses and one’s current phase of life. One attendee specifically asked, “If I survived 2008, should I consider a higher risk tolerance going forward?” Gibson responded by congratulating investors who did not abandon their strategy and continued to rebalance, but warned against an increased allocation to equity. He maintains that the road to recovery will be a bumpy ride and regardless of underlying economic value, consumer sentiment may continue to cause price fluctuations unrelated to fundamental analysis.
Gibson concluded by reminding investors that equity asset classes were tested to an extreme level, and emotional decision making can lead to poor investment results in the long term. “Yearly market returns are just noise,” he stated. “Stocks are for 10 – 20 year time horizons and should be evaluated as such.” Time tends to minimize the problem of volatility risk, and an appropriate asset allocation will help ensure that you can stay committed to a strategy for the amount of time necessary to withstand the market’s ups and downs.
Roger Gibson Visits FJY
August 19, 2009
By: Laurie Belew, MBA, CFP® and Tess Downing, MBA
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greats rewards.” Roger Gibson quoting Sir John M. Templeton
On April 23rd, Roger Gibson, CFA®, CFP®, spoke with FJY clients and friends on the topic of Multiple Asset Class Investing. Gibson is a well-known author and financial advisor and an internationally recognized expert in asset allocation and portfolio design. He is the Chief Investment Officer of Gibson Capital Management, Ltd. and author of the book, Asset Allocation: Balancing Financial Risk. Much of the conversation was focused on what Gibson believes are the four key determinants of portfolio performance.
An appropriate asset allocation is the foundation of any sound investment strategy. The selection of asset classes and the allocation of investments across the varying asset classes is a primary determinant of performance. The principle of diversification argues that combining asset classes that have low correlations (i.e., they act differently from one another) will result in a portfolio that has increased returns with lower volatility. After 2008, we see that the relationship among the different asset classes remains the same, yet the returns decreased and volatility increased. In other words, we have taken on more risk for less reward. Gibson believes that the benefits derived from asset allocation are not skill dependent, but are rather a function of how the asset classes work together.
Skill is the second determinant of portfolio performance; however, it is rare and difficult to identify. In order to successfully time the market or select stocks, one must have a disciplined due diligence process. This active management of portfolios increases expenses, and Gibson argues that with a good allocation strategy, skills-based management is unnecessary. When you begin to deploy market timing and specific security selection, higher expenses diminish returns and the portfolio is relying on the skill of an individual rather than a disciplined approach.
Asset location is also an important piece of portfolio performance. The positioning of certain tax-inefficient investments within tax-deferred accounts can greatly improve the portfolio’s after-tax returns. Of course, an investor’s ability to achieve tax efficiency is dependent upon the availability of investment funds in tax-sheltered accounts.
Investor behavior is the last, and arguably the most important, determinant of portfolio performance. The actions people take and the choices they make have much to do with their long term success as an investor. The efficient market hypothesis argues that investors use the information available and behave rationally given any market condition. Yet, we all understand that we use emotional as well as cognitive resources to make decisions. From 1984 to 2000, the average stock fund return was 14.0%, yet the average stock fund investor received an average annual return of only 5.3%…an 8.7% difference. A main contributor to this variance is that investors are often inclined to chase yesterday’s winners and do not have the skill to consistently predict tomorrow’s outperformer. Gibson argues that when pressure mounts to abandon a strategy, the advisor’s most important role is to encourage the investor to maintain discipline and stay the course.
In a year like 2008, many investors were faced with a difficult choice regarding whether to abandon their strategy. An appropriate risk tolerance is a key driver in whether investors overcame that challenge. Gibson addressed the potential reasons for re-evaluating risk tolerance, including one’s willingness to sustain further losses and one’s current phase of life. One attendee specifically asked, “If I survived 2008, should I consider a higher risk tolerance going forward?” Gibson responded by congratulating investors who did not abandon their strategy and continued to rebalance, but warned against an increased allocation to equity. He maintains that the road to recovery will be a bumpy ride and regardless of underlying economic value, consumer sentiment may continue to cause price fluctuations unrelated to fundamental analysis.
Gibson concluded by reminding investors that equity asset classes were tested to an extreme level, and emotional decision making can lead to poor investment results in the long term. “Yearly market returns are just noise,” he stated. “Stocks are for 10 – 20 year time horizons and should be evaluated as such.” Time tends to minimize the problem of volatility risk, and an appropriate asset allocation will help ensure that you can stay committed to a strategy for the amount of time necessary to withstand the market’s ups and downs.