Bill Bernstein: Rule No. 1 Is Stick To Your Plan

March 09, 2015

Investing successfully is not outguessing the market. And it’s really not about getting rich; it’s about not dying poor, Bill Bernstein, the plain-spoken advocate of passive investing says.

In a recent chat with Managing Editor Olly Ludwig, Bernstein said that more than anything, success depends on sticking to your plan. That’s true whether you favor pure-beta funds or some variation of that in the growing realm of “smart beta” strategies. As you take measure of markets, what are the key takeaways right now?

Bill Bernstein: Well, I would say that the expected return of a balanced portfolio is the lowest it’s been in financial history. We’re looking at 3 or 4 percent on stocks, and we’re looking at zero percent on bonds. Those are real inflation-adjusted figures. And when you aggregate those two?

Bernstein: Two percent—I think net of expenses, you’re going to be very lucky to get 2 percent over the next 20 years. What does that mean; just grin and bear it?

Bernstein: Yes. And the only way to get more return is by taking more risk. Good luck with that. You’re a student of smart beta and you’re steeped in the factors. What do you make of the growing popularity of these strategies?

Bernstein: First of all, let’s start with the fact that it was first really described in 1994 by Fama and French in the Journal of Finance in June of that year. And, immediately what happened is that the value factor went into one of the steepest reversals it’s ever seen. And people were just merciless toward Fama and French, saying these pointy-headed academics were describing something, and as soon as it got described it went away. It was because the “bozos” knew about it; and if the bozos know about it, it doesn’t work anymore.

But of course, over the ensuing 10 years, it did extremely well. If you were a value-oriented—or now you would call it a smart-beta-oriented investor—you’ve done very, very well. And if you average out the whole period from 1992 to now, you’d have been very smart to be value-oriented. Smart beta can mean any number of things. When you say “smart beta,” are you specifically referring to value and size, or are you going beyond that to include factors like momentum, quality, etc.?

Bernstein: I’m talking about anything that deviates from market-cap weighting in a quantitative fashion. And the biggest one, of course, is value. But there’s the small size, there’s profitability, there’s momentum. All these things can be smart beta, and they’re all being mined by the big fund providers—whether it’s DFA or RAFI or whomever. They’re all mining pretty much the same thing. Are there any of these factors that you consider to be more “mine-able?”

Bernstein: Yes; value—and especially when you measure it by price-to-book multiples, because it’s more stable compared to, say, earnings or momentum, where the needle is vibrating pretty wildly. The size factor is also fairly stable.

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