In a recent meeting, a client on the east coast shared that he had prepared for this past winter by purchasing a snow blower and heated gutters as a reaction to a punishing 2014-2015 winter season.
How was he rewarded for his preparation? By barely putting either to use in one of the mildest winters on record thanks to El Nino. In telling the story, he sighed and amusingly chalked the experience up to his ongoing struggle “fighting the battle of last year.”
We all do this, of course. It just manifests itself in different ways. Call it recency bias or a natural response to an event that’s just occurred, it’s certainly part of human nature.
In our portfolios, the most volatile asset class in which we invest is in companies located in countries whose economies are still said to be emerging or not fully developed. This can include fairly large countries such as China, Brazil and India, but also includes much smaller nations like Peru, Poland and the Czech Republic. Historically, this asset class is the source of very attractive returns, but those returns come with corresponding risk evident in the volatile returns delivered from year to year.
Looking at 2015, you might be hesitant to stick around in Emerging Markets. The DFA Emerging Markets Value fund, a mutual fund that invests in value oriented companies in the markets described above, lost more than 18% for that year. With China’s economic health in question, constant tension in Korea and a tenuous political environment in Brazil, no one could be blamed for questioning the wisdom of sticking around.
As of the end of March 2016, that same fund is the best performing asset class in portfolios, returning 8.9% in just the first few months of the year.
Looking at the end of 2015, you might have read that the Federal Reserve decided to finally nudge the Fed Funds rate up slightly and there are plans to continue such increases over the next several years. Some questioned whether bond funds would be able to hold their value in a rising rate environment.
After years of stalled results across short and intermediate term, higher quality bonds, the DFA Intermediate Government Fixed Income Fund is up 3.71% in the first quarter of 2016, with the DFA Five Year Global Fixed Income Fund and Short Term Extended Quality Fund following with 2.32% and 1.74% returns so far this year.
U.S. commercial real estate markets tanked beyond belief during the market crisis of 2008-2009. The corresponding rebound was to be expected, but many feared it had peaked and then stalled when the DFA Real Estate Securities Fund earned just 1.39% in 2013 while companies in the U.S. and the developed world soared anywhere from 20-40%. Maybe this was the time to pull back out before it dipped again.
In 2014, the fund returned 33.29% and was the best performing asset class of the year in our portfolios. Last year was positive again and this year, the fund is up 6.23% and its international counterpart is up 8.67% so far.
None of this is to say that any of these early 2016 trends will continue or that other, very different trends won’t emerge through the rest of the year.
It’s also not to suggest that buying a snowblower is always a good or bad idea (assuming you live somewhere that at least occasionally sees snow).
In fact, I suspect our client might very well have used his snowblower just this past week as Winter Storm Ursula dumped a rare heaping of April snow on the Northeast.
The point is more that making these kinds of decisions based on very short term performance sets us up for failure time and again. That snowblower will eventually go to good use. The various asset classes in our portfolio will continue to fluctuate for all kinds of reasons in the short term, but are likely to play to their averages and provide smoother sailing throughout our investment experience.
Diversification is about being prepared for all seasons. It doesn’t make the storms any easier, but over the long run, it continues to be the winning approach.