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I would have thought that was implicit in the discussion of low volatility funds. Dividend paying stocks tend to have lower volatility because of their moderately assured income stream - the same stream that makes them susceptible to interest rate risk, as discussed in the article.
Here are a couple of WSJ articles on this point:
http://www.google.com/search?q=high+hopes+for+'low+volatility'+funds "Many low-volatility stocks pay high dividends. .. 'The PowerShares fund should capture the low-volatility effect better, [] but the flip side to that is that you're taking on more sector risk.' That's because the PowerShares fund tracks an index composed of the least volatile stocks in the S&P 500, and becomes heavily weighted toward sectors like utilities (recently around 25% of the index, compared with about 3% for the S&P 500)."
http://www.google.com/search?q=beware+'low+volatility'+ETFs (okay, technically this one's from Barron's) "A BETTER BET: dividend-growth stocks. They're steady hands, with more attractive valuations and less interest-rate sensitivity. ... VIG ... SCHD"
The article failed to emphasize several essential factors and concepts that are the true drivers at controlling portfolio risk: global market diversification and cost minimization.
What was said was somewhat important at the margins; what was not said is fundamentally really significant.
Best Wishes for a Happy and profitable Holiday season.
If you examine correlation history, and not just recent, global markets very often do not provide much diversification. Cost reduction can be v good, though not if your cheap active funds do better (the few that do so consistently). Not paying an adviser works best for me. A lame article, and ending with 12y cash/bonds to boot. Wow. How *not* to survive a long retirement. That adviser has done no study of historical bounceback, unless he is going to cite many decades ago.
I too am not now a financial advisor client. I did use one in the early 1960s until I realized he had more incentives to churn my portfolio rather than increasing its value.
I recognize my personal experience is not universal, and the financial advisor industry can and does provide useful services for many customers. They educate and hold hands for those with weak stomachs or itchy trigger fingers. To paraphrase a Charlie Munger observation: As a money manager, he has experienced 50% drops 3 times in 50 years. The market is always 2 steps up and 1 step back. If you can't handle the 1 step back you shouldn't be in the market.
I suspect you suffered a dyslectic moment (it happens to me too) in your opening statement: “If you examine correlation history, and not just recent, global markets very often do not provide much diversification.” I remembered the data with just the opposite impact. So I checked to verify.
I used Vanguard as my primary historical data source, and updated their data summary and analysis with work I completed using Portfolio Visualizer.
Here is the Link to the Vanguard study titled “ Considerations for Investing in non-U.S. Equities”:
The report was released in March, 2012. It concluded that although correlation coefficients have closed towards a perfect correlation of One value, diversification still mitigates individual investment class volatility and contributes towards end wealth. Vanguard concluded that a 20% to 40% foreign holding equity position had merit. Beyond the 40 % level the law of diminishing returns took hold, and in fact, acted to retard the portfolio.
Correlation coefficients are highly volatile entities. Just observe the noise like signal of the 1-year data and contrast that against the 10-year signal like data, both displayed in the Vanguard 15 page report. The data is given for many foreign Countries. It clearly demonstrates lower correlation coefficients in yesteryear with a definite tendency towards closure recently. In yesteryear, the correlations resided in the 0.4 to 0.6 range; today, those correlations are North of 0.8.
Since the Vanguard data ended a few years ago, I updated it with an analysis I made using the Portfolio Visualizer website source. Here is the Link to the Portfolio Visualizer Asset Correlation toolkit:
When I said “global market diversification” I meant it in its most general sense to include all categories of asset class options. I updated the Vanguard study by examining the more recent correlation coefficients among the S&P 500 (VFINX), the total Bond market (BND), the FTSE (VEU), Emerging markets (VWO), and REITs (VNQ) as an incomplete set of primary holdings. I did mix mutual funds and ETFs since they reflect my current positions.
I had the Portfolio Visualizer compute correlation coefficients for 1, 3 and 5 years of the most recent data. Results bounced around, reflecting the unstable nature of correlations. The Bond asset retained a negative correlation against the equity holdings. The equity correlations were in the high range, very similar to the quoted Vanguard data sets with one exception. The 1-year Emerging markets correlation with the S&P 500 reverted backward to a 0.66 value.
Sorry for this detailed examination, but I felt your opening statement needed further clarification. Perhaps we are using different definitions for the short-term and the long-term. Timeframe disparities cause investment misunderstanding and need careful definition. Unfortunately, by selectively choosing timeframe, almost any position can be supported with a prudently screened data set. Statistics must always be fully scrutinized.
We agree that the article could have been more meticulously researched and more comprehensive. The cautionary “reader beware “ is warranted here.
Now, if an investor rode the market bottom through March of 2009 and didn't sell, well; I suspect they are happier now. But, for those who watched from October of 2007 and saw the wide gyrations of late 2007; too many lost their appetite as well as some money, as they bailed out.
IMHO, the only thing that saved anyone's monies was to be in investment grade bonds, including gov't. issues. The rest was highly correlated to the downside, just some worse than other equity. In this case, IMHO = been there, done that; first person, a real view; not just "old" charts, graphs and reported stories to read.
Diversification is a risk mitigation and not a risk elimination tool. No risk translates to very meager rewards beyond inflation rates.
It is a nearly impossible chore to identify an equity or equity equivalent asset class that has a negative correlation coefficient compared to equities. Typically, Gold comes close with a correlation coefficient that hovers around 0.1. Some equity-like investment classes do have negative correlations for short periods. But any negative coefficient is ephemeral.
The Portfolio Visualizer (PV) website provides an excellent example. Here is a Link to a PV table that includes numerous asset classes from April, 2009 to the present:
Note that only Bond entities show negative values. But also take note of the disparity in annual returns for these products. The risk/reward tradeoff almost always exists. Diversification is not quite a free lunch.
The trick is to decrease portfolio volatility a bunch (like a factor of two) while simultaneously retaining most (but not all) of the expected returns. That’s the name of the game with the Efficient Frontier. It is a doable task.
I’m sure you help your clients to achieve that target goal. Each individual investor must decide for himself how much return he is willing to forego for any given risk reduction. Only the investor knows his true risk tolerance. And even that changes with time and circumstances. Also that investor lies just a little, including to himself. It’s a tough nut.
Perhaps in the future things will return to the rather less correlated statuses. But in retirement I have cut back on general international funds and bothering to research them while contrarily adding (small) some Matthews Asia and a couple of Japan funds.
Thank you for your reply. I originally thought that you indeed dropped a “not” in your opening statement.
Apparently that was not the case, and you provided 3 references that purportedly support your memory of their writings. As President Ronald Reagan said: “trust, but verify”. As a matter of personal policy, in most instances I do try to verify, even my own flawed memory.
In the financial universe, almost nothing is totally black or white, but rather varying shades of gray that change over time. Diversification mostly works well, but does suffer from shortfalls and application limitations. The market experts mostly rate it a net plus when scoring the advantages and the disadvantages.
The three articles that you referenced do discuss both the merits and the hazards of diversifying, especially in the International marketplace. But your choices were somewhat puzzling. Their bottom-lines strongly agree with the position that I presented; most recently, correlations, particularly International ones, have collapsed towards the perfect correlation One level. That tends to neutralize the benefits of holding international elements in a portfolio, but does not completely eliminate their advantages.
In the Michael Schmidt article, he concludes that: “There has, however, been a trend of increased correlation between the U.S. and non-U.S. markets.” That’s precisely the thrust of my comments.
In the first John Waggoner article, he says: In “The past five years, Lipper's large-cap core international and large-cap domestic core indexes have a 94% correlation.” The Vanguard study shows that was not the situation 10 and 20 years ago.
In the second John Waggoner article he asks and answers as follows: “Is it time to re-think diversification strategies? No. But it's a good time to make sure you're really diversifying your portfolio.” In another section, he says: “And diversification is a good strategy.” Still further in the reference: “Foreign stocks tend to move in lockstep with U.S. stocks these days — particularly when the markets are down.” Again, this column really reinforces the arguments that I offered.
Enough! Your references added depth to the Harry Markowitz academic findings that diversification is important when assembling an efficient and effective portfolio. Any correlation coefficient between two components below “One” helps to lower the portfolio’s overall volatility (standard deviation).
That’s goodness to enhancing compound returns over the years, dampening negative market swings, lowering the odds for a losing annual return, and influencing an investor to control emotions to stay the course. Diversification does not eliminate risk from the marketplace; it does help to manage it.
Time to move ahead now. This is a minor matter that has likely wasted too much of both your valuable time and mine. Memory should never be fully trusted.
Comments
Here are a couple of WSJ articles on this point:
http://www.google.com/search?q=high+hopes+for+'low+volatility'+funds
"Many low-volatility stocks pay high dividends. .. 'The PowerShares fund should capture the low-volatility effect better, [] but the flip side to that is that you're taking on more sector risk.' That's because the PowerShares fund tracks an index composed of the least volatile stocks in the S&P 500, and becomes heavily weighted toward sectors like utilities (recently around 25% of the index, compared with about 3% for the S&P 500)."
http://www.google.com/search?q=beware+'low+volatility'+ETFs (okay, technically this one's from Barron's)
"A BETTER BET: dividend-growth stocks. They're steady hands, with more attractive valuations and less interest-rate sensitivity. ... VIG ... SCHD"
The article failed to emphasize several essential factors and concepts that are the true drivers at controlling portfolio risk: global market diversification and cost minimization.
What was said was somewhat important at the margins; what was not said is fundamentally really significant.
Best Wishes for a Happy and profitable Holiday season.
I too am not now a financial advisor client. I did use one in the early 1960s until I realized he had more incentives to churn my portfolio rather than increasing its value.
I recognize my personal experience is not universal, and the financial advisor industry can and does provide useful services for many customers. They educate and hold hands for those with weak stomachs or itchy trigger fingers. To paraphrase a Charlie Munger observation: As a money manager, he has experienced 50% drops 3 times in 50 years. The market is always 2 steps up and 1 step back. If you can't handle the 1 step back you shouldn't be in the market.
I suspect you suffered a dyslectic moment (it happens to me too) in your opening statement: “If you examine correlation history, and not just recent, global markets very often do not provide much diversification.” I remembered the data with just the opposite impact. So I checked to verify.
I used Vanguard as my primary historical data source, and updated their data summary and analysis with work I completed using Portfolio Visualizer.
Here is the Link to the Vanguard study titled “ Considerations for Investing in non-U.S. Equities”:
https://personal.vanguard.com/pdf/icriecr.pdf
The report was released in March, 2012. It concluded that although correlation coefficients have closed towards a perfect correlation of One value, diversification still mitigates individual investment class volatility and contributes towards end wealth. Vanguard concluded that a 20% to 40% foreign holding equity position had merit. Beyond the 40 % level the law of diminishing returns took hold, and in fact, acted to retard the portfolio.
Correlation coefficients are highly volatile entities. Just observe the noise like signal of the 1-year data and contrast that against the 10-year signal like data, both displayed in the Vanguard 15 page report. The data is given for many foreign Countries. It clearly demonstrates lower correlation coefficients in yesteryear with a definite tendency towards closure recently. In yesteryear, the correlations resided in the 0.4 to 0.6 range; today, those correlations are North of 0.8.
Since the Vanguard data ended a few years ago, I updated it with an analysis I made using the Portfolio Visualizer website source. Here is the Link to the Portfolio Visualizer Asset Correlation toolkit:
http://www.portfoliovisualizer.com/asset-correlations
When I said “global market diversification” I meant it in its most general sense to include all categories of asset class options. I updated the Vanguard study by examining the more recent correlation coefficients among the S&P 500 (VFINX), the total Bond market (BND), the FTSE (VEU), Emerging markets (VWO), and REITs (VNQ) as an incomplete set of primary holdings. I did mix mutual funds and ETFs since they reflect my current positions.
I had the Portfolio Visualizer compute correlation coefficients for 1, 3 and 5 years of the most recent data. Results bounced around, reflecting the unstable nature of correlations. The Bond asset retained a negative correlation against the equity holdings. The equity correlations were in the high range, very similar to the quoted Vanguard data sets with one exception. The 1-year Emerging markets correlation with the S&P 500 reverted backward to a 0.66 value.
Sorry for this detailed examination, but I felt your opening statement needed further clarification. Perhaps we are using different definitions for the short-term and the long-term. Timeframe disparities cause investment misunderstanding and need careful definition. Unfortunately, by selectively choosing timeframe, almost any position can be supported with a prudently screened data set. Statistics must always be fully scrutinized.
We agree that the article could have been more meticulously researched and more comprehensive. The cautionary “reader beware “ is warranted here.
Best Wishes.
Scroll down the page (from Jan. 30, 2009) a tiny bit and click on the graphic to enlarge.
Market returns, including 2008
Now, if an investor rode the market bottom through March of 2009 and didn't sell, well; I suspect they are happier now. But, for those who watched from October of 2007 and saw the wide gyrations of late 2007; too many lost their appetite as well as some money, as they bailed out.
IMHO, the only thing that saved anyone's monies was to be in investment grade bonds, including gov't. issues. The rest was highly correlated to the downside, just some worse than other equity.
In this case, IMHO = been there, done that; first person, a real view; not just "old" charts, graphs and reported stories to read.
Regards,
Catch
Thank you for your submittal.
Diversification is a risk mitigation and not a risk elimination tool. No risk translates to very meager rewards beyond inflation rates.
It is a nearly impossible chore to identify an equity or equity equivalent asset class that has a negative correlation coefficient compared to equities. Typically, Gold comes close with a correlation coefficient that hovers around 0.1. Some equity-like investment classes do have negative correlations for short periods. But any negative coefficient is ephemeral.
The Portfolio Visualizer (PV) website provides an excellent example. Here is a Link to a PV table that includes numerous asset classes from April, 2009 to the present:
http://www.portfoliovisualizer.com/asset-class-correlations
Note that only Bond entities show negative values. But also take note of the disparity in annual returns for these products. The risk/reward tradeoff almost always exists. Diversification is not quite a free lunch.
The trick is to decrease portfolio volatility a bunch (like a factor of two) while simultaneously retaining most (but not all) of the expected returns. That’s the name of the game with the Efficient Frontier. It is a doable task.
I’m sure you help your clients to achieve that target goal. Each individual investor must decide for himself how much return he is willing to forego for any given risk reduction. Only the investor knows his true risk tolerance. And even that changes with time and circumstances. Also that investor lies just a little, including to himself. It’s a tough nut.
Have a great Holiday season. Best Wishes.
It all depends on how much diversification the word wants to mean.
I was going chiefly by my memory of
http://www.investopedia.com/articles/financial-theory/09/international-investing-diversification.asp and
http://usatoday30.usatoday.com/money/perfi/columnist/waggon/story/2011-12-01/euro-crisis-your-portfolio/51554946/1 and
http://usatoday30.usatoday.com/money/perfi/funds/2009-01-06-diversification-stock-fund-losses_N.htm (note the Doll quotes).
Perhaps in the future things will return to the rather less correlated statuses. But in retirement I have cut back on general international funds and bothering to research them while contrarily adding (small) some Matthews Asia and a couple of Japan funds.
Thank you for your reply. I originally thought that you indeed dropped a “not” in your opening statement.
Apparently that was not the case, and you provided 3 references that purportedly support your memory of their writings. As President Ronald Reagan said: “trust, but verify”. As a matter of personal policy, in most instances I do try to verify, even my own flawed memory.
In the financial universe, almost nothing is totally black or white, but rather varying shades of gray that change over time. Diversification mostly works well, but does suffer from shortfalls and application limitations. The market experts mostly rate it a net plus when scoring the advantages and the disadvantages.
The three articles that you referenced do discuss both the merits and the hazards of diversifying, especially in the International marketplace. But your choices were somewhat puzzling. Their bottom-lines strongly agree with the position that I presented; most recently, correlations, particularly International ones, have collapsed towards the perfect correlation One level. That tends to neutralize the benefits of holding international elements in a portfolio, but does not completely eliminate their advantages.
In the Michael Schmidt article, he concludes that: “There has, however, been a trend of increased correlation between the U.S. and non-U.S. markets.” That’s precisely the thrust of my comments.
In the first John Waggoner article, he says: In “The past five years, Lipper's large-cap core international and large-cap domestic core indexes have a 94% correlation.” The Vanguard study shows that was not the situation 10 and 20 years ago.
In the second John Waggoner article he asks and answers as follows: “Is it time to re-think diversification strategies? No. But it's a good time to make sure you're really diversifying your portfolio.” In another section, he says: “And diversification is a good strategy.” Still further in the reference: “Foreign stocks tend to move in lockstep with U.S. stocks these days — particularly when the markets are down.” Again, this column really reinforces the arguments that I offered.
Enough! Your references added depth to the Harry Markowitz academic findings that diversification is important when assembling an efficient and effective portfolio. Any correlation coefficient between two components below “One” helps to lower the portfolio’s overall volatility (standard deviation).
That’s goodness to enhancing compound returns over the years, dampening negative market swings, lowering the odds for a losing annual return, and influencing an investor to control emotions to stay the course. Diversification does not eliminate risk from the marketplace; it does help to manage it.
Time to move ahead now. This is a minor matter that has likely wasted too much of both your valuable time and mine. Memory should never be fully trusted.
Have a great Holiday season. Best Wishes.