2014 has been an interesting year.
According to S&P Capital IQ Fund Research, “80% of running large-cap mutual funds have underperformed the S&P 500 in 2014.” The S&P SPDR (SPY) is simply not an easy index to beat, though we’ve been able to do so in the Best Ideas portfolio since inception.
To nobody’s surprise, many investors have been lured to indexing thanks in part to the promise of mediocrity. But even for a tried-and true indexer (a Boglehead), it is quite valuable to keep a good stock-picker handy. Think about the boost from just adding a few shares of Best Ideas portfolio holding Apple (AAPL) or Altria (MO), or from completing the round trip in Baidu (BIDU) from buy to sell. Just two shares of Baidu would have left you with a profit after Valuentum subscription fees. Yep, just two shares! In a portfolio dominated by mutual funds, ETFs and bonds, even a few stocks could really bolster returns.
We know many advisors have moved primarily to fund-based investing for a variety of reasons, but leaving out individual security analysis could be a costly move for clients. For one, 100% of indexers are guaranteed to trail the market due to the costs to run the index fund, and when these index funds are added to the 80% of large-cap managers struggling to keep up with the benchmark, fund investing looks fairly bleak in 2014. The true risk of fund investing is ongoing underperformance, and leaving out individual securities could all but guarantee that.
For us, we find indexing a somewhat frightening proposition. An indexer relies on someone else to figure out what a company’s stock is worth, which may be fine as long as there are more stock pickers than indexers in the market. However, as indexers continue to proliferate, they buy more and more of the constituents of a particular index, which include both overpriced and underpriced equities. Overpriced stocks included in the index are thus bid higher, and in some cases, bid to nosebleed (irrational) levels. Over a longer-term horizon, we would expect value-oriented, more concentrated portfolios to exceed the return of the S&P 500 due in part to this concern.
Fund performance hasn’t been pretty in 2014, and we think this helps support the view that stock selection should always have a place in anyone’s portfolio (the percentage of which should vary depending on risk tolerance and goals, of course). A collection of mutual funds in a portfolio setting can, at times, be considered over-diversifying, and nobody wants to pay those extra fees! Don’t fire your stock picker!
Note: With a large number of industries updated recently, tomorrow, September 24, will be a big day for the updating of the many stock screens on our website. We expect a refresh before end of day.