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About 3 months ago I received a call from my representative for a financial management firm asking if I wished to change my asset allocation model to a more conservative model. By this she meant holding fewer stocks and more cash or bonds. While I appreciated the call and now acknowledging with hindsight that the market still had more declines ahead my answer was that the real time to have made such a move would have been a year earlier. Another financial company recently invited me to hear a speaker with a fund that does well during market downturns. I now frequently read articles about managers and funds that do well during market corrections and receive invitations to promotional speeches for such funds. There is so much fear now among investors it is likely that more money will pour into defensive funds for very understandable reasons. Loosing half of your equity portfolio value is painful!
While there is undoubtedly a lot to be said for a fund manager that has managed to turn a profit over the past couple of years is this the time to consider a move to a more defensive strategy or would it be a move based on the past? I am always interested in strategies that do well in both up and down markets but my inclination at this point in the bear market decline that began in October 2007 is to make a note of a defensive fund for another time a time when the market has performed on the high end of the historical norms for a few years instead of wanting to invest in a defensive fund now that the market is well into bear territory. With investing it is important to be forward thinking by asking yourself the following questions:
- What has already happened over what time frame and what is most probable to happen over the next few years?
- What has historically happened in subsequent years for the market as a whole after such a scenario?
- How has the specific investment I am considering buying or selling performed after such a scenario?
With regard to these questions the S&P500 finished 2007 with a 3.5% gain but included a decline that began in October of that year. In 2008 the S&P was down almost 38% and for this year the market is down around 22%. If you are considering a specific investment ask the company for annual performance figures since the fund began also known as inception. It may not be in their usual marketing material but it can be provided upon request.
In examining the data notice how the fund performed during the years after the 2000 to 2002 correction. While the numbers support that the economy is much worse now than during the early 2000’s and this period may be somewhat different it will likely give you some idea of how the fund performs following a bear market. If the fund is a defensive fund that either sells stocks short or moves into cash based on certain indicators the fund likely outperformed peers during corrections but likely underperformed in the years following the correction. Finally be aware that the market may indeed finish 2009 in the red again but think in terms of probabilities and longer time frames.