By George W. Karpus
The Daily Record Newswire
The key question to ask when measuring investment success is: Who has the most monies after a five- to 10-year period of time, net of all fees and expenses?
The question seems relatively simple, but there are many underlying variables that if not simultaneously analyzed can lead to a skewed perception of success. Clearly, then, improperly answering the question can cost you and your portfolio greatly, while properly answering it can benefit you financially.
My nearly 40 years in the investment industry have taught me that some of the key variables in helping to measure the question of investment success are those I’ve included in this week’s column.
First, as any good financial advisor will tell you, diversification is key. If your portfolio is not diversified, one period of “success” might not be repeatable, and you will be much more susceptible to risks that aren’t properly spread out.
How diversified should you be? It is my belief that long-term investors should create portfolios with exposure to at least 600 securities worldwide and generally have a time horizon of 10 years or more. Academic studies also show that it takes 50 different securities to diversify one investment style.
Total returns should be measured on a time-weighted basis, net of fees and expenses, and should be reviewed not just for comparing sectors but for the overall portfolio. Again, longer periods of time such as five- and 10-year periods should be emphasized to smooth out any anomalies.
Third, trustees, board members and investors generally need to identify and separate any advice on how to invest (asset allocation) from the performance comparisons of the different sectors of stocks, bonds and alternatives. Studies show that up to 90 percent of an investor’s total return is attributed to asset allocation decisions.
With respect to that variable, it is critical to be careful of consultant/advisors who spin performance results as:
• A comparison against organizations with similar asset mixes;
• Comparisons against a small universe;
• Changing benchmarks or universes;
• Comparing short or select time periods; and
• Focus on individual managers and strategies versus the overall portfolio.
In order to address such issues, investors, board members and trustees should move their consultant/advisors to the “no spin zone”:
• Demand regular review of time-weighted rates of return for one-, three-, five-, seven- and 10-year rolling time periods net of fees and expenses. The key is to emphasize longer periods, first to better assess performance and second to assess asset allocation decisions/recommendations.
• Compare against large universes of consultants and managers (2,000 portfolios and 1,500 managers).
• Maintain consistent benchmarks or indices.
• Review the five- to 10-year asset allocation decisions and their implementation.
• Spend more time reviewing the asset allocation decisions than the comparisons of managers.
• Spend more time on fundamental risk analysis versus statistical risk analysis.
Lastly, don’t forget to thoroughly review your consultant’s/advisor’s advice on how to invest. Review their recommendations from five to 10 years ago — 70 to 90 percent of an investor’s return comes from the basic asset allocation decisions usually provided by a consultant/advisor. For example, if your consultant recommended an asset mix 10 years ago that was weighted heavily with stocks and underweighted in bonds, the best sector managers could not prevent your portfolio from poor returns. If the consultant over-weighted domestic stocks versus international, you moved even lower in relative results. Consider the returns over the last 10 years.
Bonds performed best, followed by foreign stocks. Investors lost money in U.S. stocks over that time period. What were your consultants/advisors telling you in the middle of 2000? Were they telling you U.S. stocks were more overvalued than they were in 1929? Did they increase your exposure to bonds at the expense of U.S. stocks? Were they increasing your allocation to foreign stocks with emphasis on the emerging markets? Did they increase emphasis on alternatives?
At Karpus, we did those things and, in fact, in fall 2009 we went one step further, instituting the Karpus Charity Challenge in an attempt to help local charitable organizations and educational endowments assess the very question posed by my column, and see if they were getting the most out of their donors’ dollars.
After nine months, our Charity Challenge has not produced even one external winner. Not even one of the area’s largest 90 charities has been able to prove that their managed and marketable investments have outperformed the composite of our balanced accounts over a 10-year time period (more than 600 portfolios and more than $750 million in assets that includes tax-managed individuals). We cannot help but wonder whether many institutions are not taking the Challenge because of poor long-term performance and/or advice from existing consultants.
I implore you to not succumb to apathy when looking at your own portfolio’s performance and the performance of the charities in which you invest. Don’t be afraid to ask all of the questions contained in my column and thoroughly assess the allocation decisions suggested by your consultant/advisor or the consultant/advisor of any charity to which you are considering donating.
If you do choose to ask these questions, I believe you will have a much better chance at knowing you have the biggest pot of money after a five- or 10-year time frame, net of all fees and expenses.
You have worked hard for your money.
Seek answers to these questions and let them do the same for you and the charities/educational institutions that mean the most to you.
George W. Karpus is president of Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.
