I remember my first exposure to the stock market, in my high school economics class. The teacher’s assignment: take this imaginary money and invest it in the stock market however you see fit. The person with the most money at the end is the winner.
Now I enjoyed economics, and I enjoyed research, so upon hearing the assignment, the wheels in my head started spinning. “This should be a piece of cake,” I thought…find the best performing companies and invest heavily. My tragic error? Using short-term performance to try and predict winners. Needless to say, I failed miserably at this assignment.
Fast forward to my first year working in the finance industry, and being introduced to Modern Portfolio Theory. I remember someone questioning why we wouldn’t consider moving the total value of their portfolio to the emerging markets class of assets, seeing how that class had the best three year run of any asset class in the world economy at the time. Add to that everyone’s infatuation with China as the emerging power in the world, and I started to wonder if there wasn’t any merit to this argument. After reviewing the compelling arguments set forth in all the literature I had exposure to, and remembering the valuable lesson I learned in high school economics, I told myself that sticking with the plan was the way to go. *
2008 was the year following this lesson and emerging markets had the worst performance of any asset class on the globe — followed in 2009 by being the best again, and in 2011 being the worst again. In hindsight, I’m sure this fluctuation could be explained by global events and the like, but that is not important. No one could have had any idea, before each of these years, how emerging markets might perform in the following period.
This is certainly not an indictment on emerging markets as an asset class, as it has actually performed quite well in the last 15 years. It is however an indictment on stock picking and market timing. There are no statistics out there that indicate anyone in the universe can successfully pick winners year after year on a consistent basis. There might be managers that get it right a couple years in a row, which can simply be explained by the old bell curve we learned about in statistics class. There are going to be winners every year and there are going to be losers every year, and someone is going to luck into outperforming the broad market index for a short period of time. But if picking winning stocks is hard…identifying that lucky manager is nearly impossible. Why not ride the market wave, and not have your retirement assets chewed up by fees and transaction costs incurred when always buying and selling…trying to find the needle in the haystack?
* I say I told myself, because the folks I work with would have never succumbed to investing someone’s entire net wealth into a single asset class, let alone one as volatile as emerging markets.
Index return data analyzed, provided by: MSCI Emerging Markets Index (gross dividends), copyright MSCI 2013, all rights reserved. Other data provided by Standard & Poor’s Index Service Group, Russell Investment Group, Dow Jones Indexes, Fama/French, Bloomberg, MSCI, Dimensional, Style Research, London Business School, Nomura Securities, Merrill Lynch, Pierce, Fenner & Smith, Incorporated, Barclays Bank PLC, & Citigroup