Swedroe: Tactical Approaches Miss The Mark

February 08, 2017

We can define “conventional wisdom” as ideas that have become so ingrained that few people ever question them. Millions of people believing in an idea, however, doesn’t make it true. Yes, conventional wisdom can be wrong. For example, at one time, millions of people believed the Earth was flat, and that the Earth was the center of the universe.

Time For Tactical?

In an article on InvestorPlace, headlined “3 Vanguard Funds That Are Taking on Water,” the author recommended that now was a good time for tactical investors to start selling shares of certain types of funds.

He went on to provide his logic specifically for recommending the sale of three of Vanguard’s mutual funds: “With an aging bull market that is much closer to the end than the beginning—and rising interest rates marking the mature phase of the business cycle—we can identify some specific areas of the market that investors will want to avoid … or at least minimize exposure.”

One of the three funds the author listed was Vanguard’s REIT Index Fund (VGSIX). His logic was based on the conventional wisdom that “mutual funds that hold interest-rate-sensitive stocks, such as real estate investment trusts, will likely fall behind the broad market indices in the short run. This makes Vanguard REIT Index Fund Investor Shares a likely underperformer to sell now.”

He added: “Like bonds, prices for REITs have historically had an inverse relationship with interest rates: When rates are low or falling, REITs generally perform best; when rates are rising, REITs typically underperform.”

Doing The Math

Let’s go to our trusty videotape to see how REITs actually performed during the worst period of rising rates in the postwar era. At the start of 1978, the three-month bill rate was at 6.4%. But by August 1981, it had reached 15.5%. During the period 1978 through 1981—the sharpest rise in short-term rates we have seen—the Dow Jones U.S. Select REIT Index provided an annualized return of 26.9%, far outperforming the S&P 500, which returned 12.3%.

Now, this negative relationship didn’t always hold true. However, if conventional wisdom and the author of this article were correct, we should see a positive relationship between the returns to fixed-income investments and REITs.

But, for the period 1978 through 2016, the annual correlation of returns to the Dow Jones U.S. Select REIT Index and the BofA Merrill Lynch 1-3 Year Treasury and Agency Index, the Five-Year Treasury Index, and the Bloomberg Barclays Long-Term US Treasury Bond Index were all actually slightly negative, at -0.03, -0.12 and -0.09, respectively. In other words, the correlations were effectively zero. So much for conventional wisdom, and the logic of the author’s recommendation.

 

Find your next ETF

CLEAR FILTER