Imagine yourself in an empty room that has three doors. This room represents the investment year of 2013 and the door that they are about to open is where they hope or think the best returns will be for 2014.
Door #1 – Bonds: Very few people are near this door. There certainly isn’t a line to open the door and most investors walking by seem smug as they peek at the lonely door along with the depressed looking people waiting nearby. It’s clear to most that the bond markets have already begun to crumble. With interest rates that are sure to rise this asset class feels like dead money and the ‘writing is on the wall’ for flat to dismal returns. Some of the folks in line are creatures of habit. In other words, bonds have treated them quite well over the past 30 years and although 2013 has been relatively dismal for them, they haven’t quite changed the way they eat or live yet and still feel that waiting in this line makes sense.
Other investors in the bond line have just come over from Door #2 which is where there is still quite a ruckus going on. They seem relieved and in some cases content to have left the madness of the Door #2 line but they also aren’t very optimistic as to what awaits. As they glance back over at the buzz and excitement from the Door #2 line they almost have a nostalgic or remorseful feeling that they may have left too early. The line they’re in now (Bonds) feels like a funeral home compared to the party they just left! So…what is Door #2 all about?
Door #2 – Stocks: What a crowd we have here! Not only is there a long line but it’s almost becoming a crowd. People aren’t standing in an orderly fashion and some have no idea why they’re in this line to begin with. The odd thing about this line of folks is that some are extremely nervous waiting for the door to open but on the other hand they feel compelled to stay in line and don’t want to lose out on what might be waiting on the other side.
Another interesting thing about the folks in this line is comparing those who are in the front versus those who are in the back of the line. The investors who are in the front have been here most of 2013 and although they’re not banging on the door to get in, they’ve been at this long enough to know that what awaits them may be a lot bumpier of a road than the one they just travelled. As you hopefully know, anyone who had stocks has done well in 2013. Any mutual fund with stock exposure is probably up this year and that either causes some to think they’re smarter than they really are or others to want and expect more of the same type of returns.
Those that have joined the back of the line look a bit disheveled. They got here in a rush and look like the proverbial “late to the party” types. They want stocks now but in many cases have no clue as to which ones to buy. Will they buy what’s scorching hot right now or try and find value in areas like Emerging Markets? If history is a guide this group at the back of the line will buy Netflix (NFLX) or Tesla (TSLA).
Door #3 – Managed Futures: There are several people waiting in line here but a few seem flat-out disgruntled; they don’t want to be here and some look as though they are defeated. Towards the back of the line there is a man and a woman calmly chatting and observing the other investors in the room. The woman had just been over near the bond door and the man stepped away from the craziness of the stock crowd. Here they join each other waiting for the Managed Futures door to open and they are patiently comparing notes and observations about the lines they were just in.
Others waiting for the Managed Futures door to open are visibly upset. For the past few years they have seen nothing but disappointing returns. One investor is becoming rather loud and agitated that his financial advisor had suggested buying into this type of strategy so that once the stock and/or bond markets sell off he would theoretically have something that “zigged while the other asset classes zagged”. He went on to say that it’s done nothing but drift lower while the market is on fire. Another investor chimes in, “Yeah…mine too…She said it was sort of like the adage of the best time to fix your roof is on a sunny day?”
A very quiet but analytical type of gentleman speaks up and attempts to interrupt those who are getting impatient and losing their tempers. He finally commands their attention and says. “I’m expecting a special guest today and while he sometimes isn’t very pleasant to spend time with, he often imparts wisdom on me. During our last meeting in 2008 he reminded me that over the last five worst drawdowns for the S&P 500, Managed Futures were up double digits in each of those years.”
The man went on to say “You do indeed need to have investments that don’t move in tandem with another. Look for investments that are inversely correlated to each other. It’s very much like certain cooking ingredients too. For example, you may love a “sweet & sour” recipe or perhaps one that is spicy. These dishes are enhanced by a certain ingredient, such as hot sauce, but you certainly wouldn’t eat that item by itself, right?”
“Lastly, don’t feel bad about joining me in this line. I spent some time behind Door #1 and Door #2 but my wise friend informed me that adding Managed Futures to a portfolio actually reduces overall portfolio risk over time. On it’s own it’s of course a volatile asset class and perceived as extremely risky. Reducing some exposure to Stocks and some more from Bonds has historically done something we all want; it actually increases the average annual return while decreasing standard deviation. (higher long-term returns with lower risk!). My apologies for eavesdropping but if you get the chance to meet my wise friend, please remember this”. The man then turned his shoulders and casually pointed towards another growing contingent of people who were beginning to gather in the middle of the large room.
In the middle of this “investment room” is a group of people who truly don’t want to step closer to any of the doors. Call them “cash” investors or simply lump them in as “undecided”. Each of them has a similar look on their face. It’s also as though some have a large question mark floating above their head. Some of them have not wanted to buy stocks since the last whooping they received in 2008. Sadly enough, many of them got out of the stock market at almost the worst point and have now missed a huge run-up. Those that left the bond line are also not comfortable in doing anything but wait for things to settle out but that could be a very long time. The last few standing are wanting to leave the room entirely but as they look for an exit they notice something peculiar.
One more person enters and approaches the group of people in the middle of the room. He personally attempts to introduce himself to each investor before he makes his rounds to the other groups waiting behind their respective doors. The man is sharply dressed but his face is extremely hard to read. If you were to play poker against him he would own your house before the evening was over! His smile looks inviting but it could also be perceived as a frown masking a very vindictive and volatile temper. The man begins handing out index cards with simple words on them. They say things like : Inflation, Tapering, Interest Rates, Unemployment, Valuations, Politics, Terrorism, and Taxes. The investors look quizzically at the man as he then walks away.
They then turn the card over and read the following sentence: “It’s been a pleasure meeting you. My name is Mr. Market and I wish you much success in 2014. Be wise in your choices and try not to be married to what worked yesterday. The only way to beat me is to have your foot in more than one line…even when it’s not comfortable to do so.”