Dow Jones sent me an email this morning inviting yours truly to partake of the enlightened analysis in The Hulbert Financial Digest, a newsletter edited by Market Hulbert that evaluates other investment newsletters. No doubt thousands received similar invites. But while it was one more marketing effort, the email was intriguing for what it says about published efforts at trying to beat the market.
“More than 80% of advisory letters fail to beat the market over the long term,” the email advised, and goes on to note:
If you followed the advice of the bottom five worst-performing letters, you’d have lost almost your entire portfolio.
Because advisory letters only promote their successes, you never hear about their long-term failures!
Cut Through the Hype!
On the other hand, if you took the advice of the top 5 best performing advisory letters over the last 10 years, you’d have profited between 298% and 506%. Compare that to the Wilshire 5000 which returned 104% for the same period.
Now that’s a rather dramatic bit of numbers. Indeed, 80% of investment newsletters trail the market over the long haul, and the worst ones destroy capital at a disturbingly high rate. (The “market” here is defined as a broad measure of U.S. equities, or so it appears based on the email copy.) On the other hand, a handful of letters analyzed—five, to be exact—beat the market by an impressive degree. The email doesn’t say what percentage those high five are of the total universe, but it’s reasonable to assume they’re in the top 20% (or maybe top 5%?) based on the claim that 80% fall short of the market’s performance.
Let’s consider these stats for a minute. The news that 80% of investment newsletters leave you worse off than a broad market doesn’t inspire confidence that there’s a lot of active management talent in this corner of financial analysis. There are many studies documenting that beating the market over the long run is difficult, but an 80% failure rate is a bit high compared with how actively managed mutual funds fare against a relevant index. The implication: investment newsletters suffer from an unusually high degree of inferior analysis.
Why, then, should anyone even consider subscribing to an investment newsletter? Aren’t the odds stacked against us before we even begin? If we were talking about anything other than investing, wouldn’t an 80% failure rate convince you to look to alternatives? Imagine, for a moment, that the failure rate of bridges was 80%. Would you be willing to take a chance and drive over one? Imagine similar failure rates for routine surgery, aviation, food poisoning. But apparently in money management, an 80% failure doesn’t scare off folks, or so it seems, once you recognize that financial newsletter publishing is a thriving business. If we include Internet-based pubs, the supply of published financial advice with an eye on beating Mr. Market totals something more than the population of New York City and less than the stars in the universe.
The riposte, of course, is that an intelligent analyst can cut through the noise and help you identify the winners. Really? If so, that surely would be worth something. In fact, it would be worth a lot. Indeed, the ability to identify winning newsletters that outperform the market by wide margins is such a skill as to suggest that you’d keep this information to yourself in a bid to become wealthy. That raises the question: Why can anyone buy this extremely valuable information for, say, $100 a year?
In the interest of full disclosure (while warning of the shameless plug to follow), I’m in the newsletter game too. I edit The Beta Investment Report, a monthly publication that, like countless counterparts, focuses on investing. And like every other financial newsletter, The Beta Investment Report claims to offer information of some value in the quest to make intelligent investing decisions. But where my newsletter parts company with most if not all investment newsletters is in the underlying philosophy. The Beta Investment Report isn’t trying to beat the market per se. Rather, the goal is to analyze the capital and commodity markets, review new research and generally crunch the numbers and interpret the trends in order to fully exploit the power of broad, unmanaged index mutual funds and ETFs over medium- and long-term horizons in the context of a multi-asset class portfolio.
This is harder than it sounds, but it’s a productive way to invest. The analysis starts by considering a broad, unmanaged mix of everything. In other words, the foundation of the newsletter’s focus is monitoring the risk and return profile of investing in the broad asset classes, initially weighted by market value and thereafter let loose to meander untouched. The newsletter’s proprietary Global Market Index (GMI), in other words, is a true passive benchmark for almost everyone. Theoretically speaking, it’s the optimal investment portfolio for the average investor over the infinite future.
GMI’s no silver bullet, but it does pretty well. For the past 10 years through May 31, 2010, for instance, this index posts an annualized total return 3.7%. That’s hardly impressive, but then that’s no surprise, considering that U.S. stocks were basically flat over that period while U.S. bonds overall in the investment grade space returned an annualized 6.5%.
What’s in GMI? You can see the list here, which is updated every month on these pages. In the newsletter, of course, I go into greater detail. Some of the analysis in recent issues has analyzed how a simple rebalancing strategy of GMI has boosted returns a bit. Related analysis looks at the best ETFs and index mutual funds to use for building portfolios and how close attention to product selection can limit the total cost of replicating an investable version of GMI to around 50 basis points.
Yes, there’s much more to discuss. For investors with a relatively high risk tolerance, for instance, the opportunity to make targeted allocations to risk factors beyond GMI broad holdings are reviewed as well. Adjusting Mr. Market’s asset allocation to hold higher (or lower) weights in certain asset classes can be productive at times too. Ditto for targeting narrowly defined sources of priced risk that appear to offer unusually high expected returns. And on and on. There’s no shortage of strategic-minded topics to discuss, and so there’s never a problem filling the pages of The Beta Investment Report. But starting with the context of the unmanaged market portfolio via GMI is critical.
In sum, keeping a close eye on the various asset classes and focusing on low-risk areas of managing asset allocation that have a high success rate are the first lines of attack (or maybe it’s defense) in trying to win the money game. In the investment journey that stretches out over the metaphorical 1,000 miles ahead, The Beta Investment Report concentrates on the first hundred yards or so—terrain that’s widely overlooked, ignored or summarily dismissed. Ignored or not, there’s a lot of meat on this bone. The kinds of questions that we seek to answer include: How can we capture the lion’s share of the broad market portfolio’s return with the least amount of risk? What are some low-risk techniques for trying to boost this passive benchmark return? What are the best funds that target a given asset class? What is new research in financial economics telling us that boost our strategic intelligence?
There are other ways of investing, of course, and some do quite well by moving far afield of the market portfolio. But many end up with high-priced mediocrity, or worse. That’s why most investors should start by considering the broad market portfolio, moving beyond it carefully, and selectively. The first priority: First do no harm. Winning by first ensuring that you don’t lose is a critical issue in money management, as Charlie Ellis famously explained in his book Winning the Loser’s Game. Yes, that’s counterintuitive. But this is finance, after all, and much of what appears to be clear and obvious is ambiguous if not misleading. No wonder that providing context and looking for clarity in the broader scheme is helpful. A radical idea, perhaps, but it works. The numbers speak for themselves.