While it doesn't have a sexy name like "Portable Alpha" or "Synthetic Hedge Fund," the "investment" turtle wins the serious money race every time.
Every investor wants the answer to what long-term rate of return they should expect from their portfolio without taking undue risk. As individuals, we are not alone in this quandary. Large pension plans intensely grapple with this substantive issue because of the liability involved in paying out funds to retirees. If the expected rate of return assumption declines, the employer must put in more money to fund future payments. Of course, they want to put in as little as possible given the expense burden.
The California Public Employees’ Retirement System, aka Calpers, is the largest public pension plan in the land, with $200 billion under management. Imagine the resources and attention they command from every investment expert to maximize their returns. Therefore, they are a good example to study.
From 2003, they have assumed a 7.75% long-term rate of return. Over the last 20 years, they have slightly beaten that bogie. However, in the fiscal year ending June 30, 2009, they were down a heart-stopping 23%. In a recent Wall Street Journal article, their investment advisor, Chief Executive Officer from Blackrock Inc., Larry Fink, reportedly told the board, “You’ll be lucky to get 6% on your portfolios, maybe 5% [going forward].”
FYI - Blackrock is the largest advisor in the world and has $35,000,000,000 ($35 trillion) under management, so they should know what’s up. These same concerns have captured most of the financial press and their readers, with references in almost every major publication.
What is the answer?
Mr. Fink’s comment is actually a good one, as depressing as it might seem. For example, almost all Monte Carlo simulations (whereby an investment strategy is subjected to a probabilistic range of outcomes) predict that a 4-5% withdrawal rate in a retirement portfolio is the highest rate sustainable. This means that if an investor withdraws more than that amount annually, the capital will be depleted over time, given the market ups and downs.
All of these comments harken to a key investment consideration in picking any investment or investment manager. Consistent returns, honestly derived, are extremely beneficial to long-run performance.
Two investments with the same compound annual growth rate but substantially different volatility (measured by standard deviation and/or peak-to-valley drawdowns) are not equal! One must time the entry and exit of the volatile fund to match the reporting period. Otherwise, that particular investor’s returns will not ever achieve the published number. The returns may be higher or lower depending on whether the investment was made at a peak or a valley and whether it was liquidated at a peak or a valley.
Timing optimum entries and exits is an unlikely processHow does one pick the low versus the high before making the investment? Or, how does one decide when to exit (buy low, sell high is the classic aphorism but trite)? Unless alchemy is a personal specialty, perfect timing is improbable.
Most invest when they have the cash to do soPredicting that timing, even if it may be more controllable, is hard enough.
Exit timing is usually no easy affair eitherWhat if an emergency need arises like some major unforeseen expense or losing a bonus, or worse yet, your job?
Retirement portfolios with systematic withdrawals create the most obvious challengesWithdrawals are made to live on regardless of whether the investment is at a peak or in a trough. If the withdrawal is made in a trough, any rebound in value will be lost to that capital.
Heart-stopping swoons are just that!What if there is no rebound for a particular investment or manager? At what point does the plug get pulled? Many of the biggest name-brand money managers have substantially underperformed the market averages over the last 10 years, ie, been even more negative. Do you have another ten years to experiment and renew the “hope” certificate?
In sum, return objectives should be realistically setFor example, beware the next shiny object like “Portable Alpha” or "Synthetic Hedge Funds.” Despite the nattering chatter, they have not delivered. One investment malcontent suggested to us that 5-year jumbo ($100,000 or more) Certificates of Deposit (CD’s) were the answer. He quoted 4% plus rates. In his words, there is safety and rates are attractive. Alas, we looked and found rates ranged from 2-3%, not the more optimistic 4% plus.
To get the higher rates, the money is usually locked in unless significant penalties are acceptable for emergency withdrawals. Safety is a personal assessment. Many banks are in trouble and, even with the government guarantee, it is an extreme hassle to collect if a bank craters. Further, the government safety net is limited.
Thus, while singularly unflashy, we believe the “investment” turtle wins the serious money race.
Alan Snyder, the managing partner of Shinnecock Partners has been in the investment business for over 30 years. He has been one of 12 senior executives in one of the largest securities firms, restructured a $20 billion insurance company, a many-time entrepreneur and founder of the Shinnecock investment limited partnerships, enjoying a track record of over twenty years.