Swedroe: Investor Lessons From 2015

January 25, 2016

Every year, the market provides us with important lessons on the prudent investment strategy. Many times, the market will offer investors remedial courses, covering lessons that it has already delivered in previous years.

That’s why one of my favorite sayings is that there’s nothing new in investing; there is only investment history you don’t yet know.

Last year supplied us with 10 lessons. As you may observe, many of them have appeared before. Unfortunately, a lot of investors fail to learn from them. They tend to keep repeating the same errors, which is what Einstein called the definition of insanity. That said, our first lesson from 2015 is that active management remains a loser’s game.

Lesson 1: Active Management Is a Loser’s Game

Despite an overwhelming amount of research to the contrary, InvestmentNews reported in January 2014 that an astonishing 75% of financial advisors they queried believed active managers would outperform. While the S&P 500 Index returned just 1.4% in 2015, active managers had great opportunity to generate alpha, as there was a very large dispersion in returns between the index’s best and worst performers.

For example, there were 10 stocks in the index that returned at least 46.6% and 25 that returned at least 34.2%. All an active manager had to do to outperform was overweight these superperformers.

On the flip side of the coin, there were 10 stocks in the index that lost at least 55.6% and 25 that lost at least 45.8%. To outperform, all an active manager had to do was underweight, let alone avoid, these dogs.

The 10 Best S&P 500
Performers In 2015
Return (%) The 10 Worst S&P 500
Performers In 2015
Return (%)
Netflix Inc. 134.4 Chesapeake Energy -77.0
Amazon 117.8 CONSOL Energy -76.6
Activision Blizzard 92.1 Southwestern Energy -74.0
NVIDIA Corp. 64.4 Freeport-McMoRan Copper & Gold B -71.0
Cablevision Systems 54.6 HP Inc. -70.5
VeriSign Inc. 53.3 Fossil Group -67.0
Hormel Foods 51.8 Kinder Morgan -64.7
First Solar 48.0 Micron Technology -59.6
Total System Services 46.6 NRG Energy -56.3
Google 46.6 Murphy Oil -55.6

Demonstrating that active management is fraught with opportunity, Morningstar data show that the Vanguard 500 Index Fund (VFINX) outperformed 77% of all active managers in the category of U.S. large blend stocks. (The Admiral Shares version of the fund, VFIAX, outperformed 80% of active managers.) And this counts only funds that survived the year (about 7% of all mutual funds disappear each year).

It’s important to note that this wide dispersion of returns is not at all unusual. Yet despite the opportunity, year after year, in aggregate, active managers persistently fail to outperform. For the three-, five- and 10-year periods ending in 2015, Morningstar shows that VFINX outperformed 80%, 84% and 77% of surviving funds (the Admiral Shares version performed even better). Furthermore, note that as we extend the time horizon, the survivorship bias increases. Thus, the reality is that active managers did significantly worse than these figures demonstrate.

Looking at other asset classes, we find similar results. The table below shows the performance rankings for Vanguard’s U.S. large value index fund (VIVAX), its small-cap index fund (NAESX) and its U.S. small value index fund (VISVX).

Morningstar Percentile Ranking

2015
(1-Year)
2013-2015
(3-Year)
2011-2015
(5-Year)
2006-2015
(10-Year)
Vanguard Value Index (VIVAX) 17 10 15 32
Vanguard Small Cap Index (NAESX) 38 30 24 15
Vanguard Small Cap Value Index (VISVX) 38 7 6 21

Again, the Admiral Shares versions of these funds would have performed even better.

These results show that active management is a strategy fraught with opportunity. Year after year, active managers come up with an excuse to explain why they failed that year, and then assert that next year will be different. Of course, it never is.

Lesson 2: Economy & Stock Market Are Very Different

The “conventional wisdom” among investors is that country growth rates are positively correlated with stock returns. In other words, if you want high returns, invest in countries that have high rates of GDP growth. Like much of what passes for conventional wisdom, this isn’t quite accurate.

The research shows that there’s actually been a slightly negative correlation between economic growth and stock returns. Turning to our trusty videotape, we see that while economic growth in China has slowed from double digits, in 2015 it still grew at a rate of about 6.9%. That’s almost three times as fast as the growth of our GDP, which is estimated at 2.4%.

Despite the difference in growth rates, the Vanguard 500 Index Fund (VFINX) gained 1.4% while the iShares China Large-Cap ETF (FXI | B-39) lost 11.9%, an underperformance of 13.3 percentage points.

Even more telling is that for the five-year period from 2011 through 2015, despite the Chinese economy’s much quicker rate of growth, VFINX returned 12.4% and outperformed FXI’s return of -1.3% during that period by 13.7 percentage points a year.

Lesson 3: Sell in May and Go Away Like Astrology

One of the more persistent investment myths is that the winning strategy is to sell stocks in May and wait to buy back into the market until November.

While it’s true that stocks have provided greater returns from November through April than they have from May through October, since 1926, an equity risk premium has still been at work from May through October.

From 1927 through 2014, the “sell in May” strategy has underperformed the S&P 500 by about 1.8 percentage points a year. That’s even before considering any transaction costs, let alone the impact of taxes (you’d be converting what would otherwise be long-term capital gains into short-term capital gains, which are taxed at the same rate as ordinary income).

How did the “sell in May and go away” strategy work in 2015? The total return for the period from May through October for the S&P 500 Index was 2.7%. During this period, safe, liquid investments would have produced virtually no return. In case you are wondering, 2011 was the only year in the last seven when this strategy would have worked.

The most basic tenet of finance is that there’s a positive relationship between risk and expected return. To believe that stocks should produce lower returns than Treasury bills from May through October, you’d first have to believe that stocks are less risky during those months—a nonsensical argument.

Later this week, we’ll discuss lessons four through seven, which cover what the market taught us last year about inflation, forecasts, performance-chasing and dividend-paying stocks.


Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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