Stocks around the global did not appear too concerned with the Trump turmoil, with the MSCI all-country world index unchanged by the uncertainty, rising 0. Click here to see recent Notices pertaining to the Fund if any. The performance quoted represents past performance and does not guarantee future results. All bonds in the index have at least one year to maturity.
Our point is simply that we all need to remind ourselves occasionally that in the end, MPT is a mental model, not a description of a physical reality. What does a stock index represent?
To investors of that era, an index was simply a measure of how the overall market was doing. It would not have occurred to them that the index represented a portfolio that they would want to hold, much less one that was, in theory, the best portfolio for them to hold. But that is in fact the conclusion that MPT proposes: Rather, we will simply note that the idea that there is one optimal portfolio that we would all want to hold which, logically, would have to be a miniature version of the whole market, since that is the only portfolio we could all hold simultaneously is predicated on the assumption that we all agree on how to define and measure risk, and that we all perceive the riskiness of each asset and each portfolio in the same way.
The work of behavioral economists has made it clear that this assumption about risk is invalid, so it is simply not the case that there is one portfolio that every investor would agree is optimal. MPT was largely promulgated in the s. Behavioral finance grew out of work by psychologists studying decision making in the s, and did not become widely known within the field of finance until the s.
In that period between when MPT caught on and when behavioral economists came along to demonstrate why its assumptions were so questionable, MPT had established enough of a foothold to create a significant real world consequence: We are fond of noting that everything in life has unintended consequences, so what have been the unintended consequences of the spread of index funds?
We would argue that the most significant one is that the availability of indexing has distorted the way people think about investing.
Think about the logic of holding an index fund. Essentially, you are surrendering your ability to render any judgment about which companies to invest in. If a company chooses to go public, you are obligated to buy it, because it is now part of the market portfolio.
So the choice as to whether that company ends up in your portfolio is being made not by you, but by the board of directors of the company when it decides to go public.
Is it a good business —i. If the company is public, you buy it. Two recent research papers highlight why this might not be a good idea. A company with mostly intangible assets does not need as much capital in its early stages, and hence does not need to tap the public markets in order to grow.
In addition, it is harder to value intangible assets, particularly given the way that GAAP accounting rules effectively penalize research and development expenses relative to capital spending on physical plant and equipment. The newer breed of companies prefers to deal with a smaller group of specialized private investors, who are in a position to understand and properly value their business.
But what is of particular interest to our discussion here is what this tells us about the reasons why companies eventually do go public these days. Since there is abundant capital available to such firms without going public, they have little incentive to do so until they reach the point in their lifecycle where they focus more on payouts than on raising capital. Does that give you confidence that you should be buying every company that goes public?
To do this, banks issue credit to consumers and small businesses, and fund these positions using deposits. Banks perform these activities because they are viewed to have an edge in each. Treasury bills and paying more to operate its deposit franchise than it benefited from reduced interest payments. Since , banks appear inefficient in that they have not covered their opportunity cost of capital.
Now, this is not to say that there are no individual banks that have done well. But the industry as a whole has essentially failed to earn more than its cost of capital. Does that really make sense? Consider the logic of indexing in the context of the bond market. Why would it not be equally optimal to hold a market portfolio of fixed income securities? Suppose that a country that is already heavily indebted, such as Japan, needs to continue to issue more debt every year to fund its social welfare programs, and due to its demographic profile has little prospect of ever generating enough tax revenue to start paying down that debt.
As the country keeps issuing more and more debt, in the process making its debt less and less creditworthy, are you obligated to keep buying more of that debt, simply because it makes up a larger share of the debt market? We acknowledge that professional active equity managers have complicated this situation through their inability to consistently generate better returns than index funds, which has convinced many people that index funds are a better way to invest.
We believe that to a large extent, this too is a case of unintended consequences, because the focus on indexes has altered the way that both clients and managers think and behave. Managers today generally do not focus on identifying attractive businesses ones that can earn sustained premiums over their cost of capital over time ; they focus instead on trying to figure out which stocks are going to outperform the index over some short to medium term.
These are different objectives, and they lead to different analytical methods. In other words, too many managers are following investment processes that we have little reason to believe will lead them to the most attractive businesses. The client focus on indexes has played a role as well, because managers know that many clients will not retain them if their performance falls behind that of their benchmark over a three-year period.
The fact that clients compare managers to an index leads managers to think of risk in terms of tracking error, rather than in terms of some broader measures of overall risk. In most cases, clients have many managers, each managing just a small portion of their overall portfolio, and what matters to the clients in the end is how their overall portfolio performs.
Yet because clients compare each manager to an index, the managers focus on managing their tracking error relative to that index, even though for the client, these individual tracking errors may not matter much at all to the behavior of the total portfolio. Clients might be better served by giving individual managers freer rein, so that the managers would worry less about the index and more about only investing in good businesses.
And in the process, managers have adopted methods that have made it less likely that in the long run they will generate returns that are better than an index. Far from it; we agree that MPT provides a very useful framework to think about investing, and gives us many tools that help us manage risk and understand the drivers of return in an insightful way.
Our goal has been to remind readers that MPT is in the end an economic model—intellectually fascinating, and helpful in understanding the real world, but not equivalent to, for example, Newtonian physics.
The latter enables us to make very precise and accurate predictions about the physical world at least at some scales.
MPT involves finance, which in the end is an inescapably human activity, subject to all the vagaries and unpredictability of anything that involves people interacting with each other. It does not allow us to make precise and accurate predictions.
We should never get so caught up in a model that we lose sight of what investing is really all about in the real world. Successful investing in equities is about identifying companies that create value for their owners by earning high returns on the capital that they take from those owners and invest in their business.
The fact that companies on average have been able to do that successfully is what has driven the value of the stock market up over time.
The power of zero interest rates have had an impact on the stock market. However we believe it has run its course with respect to its influence on valuations. Read to gain insight into the underperformance in U. Dividends — in the form of cash, share buybacks and debt repayments — will be a primary determinant of total equity returns in the years ahead.
Have we taken the easy way out of the most difficult economic problem in over 70 years and how should investors adjust their approach? The liquidity crisis subsides and leads us to take a cautiously optimistic outlook on the recovery of the economy. An explanation for the financial crisis and the case for why certain equities now offer compelling long-term value.
Dividends really matter; and capturing them in a low cost, diversified manner is both important and rewarding for investors. A review of government intervention during the financial crisis and the outlook for recovery. There are reasons to maintain a conservative outlook, but values exist. The recession train has officially left the station. Erratic weather patterns and an uncertain global economy; the comparisons are enlightening. Words of guidance for the informed investor to help steer clear of the rough seas on the horizon.
There are two sides to the story of the oncoming recession: The current and future destruction of equity capital within the banking system and its impact on the real economy.
A look at the fees charged by hedge funds and their effect on the investor. A look at the bursting housing bubble and the impact on the future of the global economy and financial markets. More signs that point to the weakness and vulnerability of financial services stocks. How our insights and experience tell us that simply wishing for a robust economy will not result in one. How informed investors can build a winning portfolio in the current market environment. Inflation concerns and peaking interest rates portend a slowdown in housing and economic growth.
The growing significance of free cash flow and shareholder yield as a dominant driver of future equity returns. More signs point to inherent weakness and vulnerability of financial services stocks. Why is this battle so important and why are the stakes so high? Looked at from a distance, the world is working surprisingly well. Almost all nations are experiencing real growth and interest rates are remarkably low.
Indeed, rates are lower than almost anyone postulated a few months ago. Few things matter in finance more than interest rates. It is this rate that becomes the discount rate in one form or another for virtually all investments and provides the key metric when valuing public securities.
A closer look at the housing market, where the continuation of low interest rates has created a bubble and is poised to play a vital, and potentially problematic, role. For some readers, the title of this paper may recall one of the most popular movies of At Epoch, we believe the same approach should be taken in the field of equity investing: Despite dark clouds in the distance there are plenty of investment themes to capture. The yield on U. Treasury bonds touched its lowest point in decades in What does this mean for future markets and returns?
Growth— Does it really make a difference? Globalization started in earnest in with the fall of the Berlin Wall and has accelerated in the early years of this new century. Prior to our world consisted of Europe, Japan, and the U. If the real economy and the financial economy are two sides of the same coin, what are the linkages, where can they be seen, and what drives changes within those linkages.
A draws a link between the size of the real economy, measured by Gross Domestic Product, and the size of the financial economy, measured by the Wilshire Total Stock Market Index, from December to September If research matters, it matters most in small-cap companies. The genesis of this study occurred when a client provided BEA with a list of commissions per share paid by all eight of its money managers.
The client wanted to know why the cents per share numbers varied so much from manager to manager. We replied that neither the size of the trades nor the effects of trading on the price paid for the security had been taken into account. While the fear of a trade war with China has riled markets in recent weeks, all leading economic indicators have been positive. Skip to content Epoch Perspectives.
July 2, The Return of Price Discovery Three developments the unwinding of QE, the soaring US budget deficit and the impending wall of maturities, especially of corporate bonds will engender higher volatility and wider credit spreads.
In the third part of our technology focused series we explore: December 15, The Winds of Change While regulators and many investors are focused on leverage, we are more concerned with liquidity risk, which was at the core of the crisis and will likely be again at the next one. Implications for Labor Markets and Productivity The rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets.
Impacting All Three Components of Return on Equity The rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets. September 14, Secular Stagnation: Growth Over the last two years Lawrence Summers has been an energetic proponent of the secular stagnation thesis whereby the increased propensity to save and the decreased predilection to invest acts as a drag on demand, reducing both growth and inflation, and pulling down real interest rates.
June 30, The Capital Reinvestment Strategy Return on Invested Capital ROIC is a crucial metric in evaluating companies, yet investors pay more attention to growth in earnings, which can be misleading.
Why does trade matter so much? Why has protectionism become such a prominent issue in ? What are the economic and market implications if the protectionists prevail? August 28, Contagion—A Perspective Recent events in China have sent tremors across global equity markets. Many investors are wondering how they can generate the income they need without taking on undue risk. The contrast between yields in versus , across a number of yield-oriented investment categories, illustrates this concept.
These strategies can be very sensitive to interest rate risk and also have lower income potential from the higher allocation to Treasurys. A skilled active manager has the flexibility to diversify across sectors to decrease duration risk and increase yield. An interesting historical pattern suggests seasonal technical factors can present a buying opportunity in the municipal market.
The dips, on average, can represent a good buying opportunity for investors. Investors can look at the long-term, income-generating portion of their asset allocations and potentially use these dips to take advantage of cheaper prices and higher yields. This is especially important given that income is the most important component of total return in municipal bonds over the long term.
Fixed income markets kicked off with a volatile January; however, the average active intermediate-term bond manager outperformed his or her passive counterparts by 35 basis points during a January. One basis point equals one-hundredth of a percentage point. In today's fixed income world with low interest rates, tight valuations, and arguably lower expectations for future performance, the ability to protect capital and deliver income has never been more important for clients to achieve their goals.
Active fixed income strategies at their core are designed to deliver on these outcomes by managing risk through different market environments. Delaware Diversified Income Fund. Past performance does not guarantee future results.
Chart is for illustrative purposes only. Institutional shares may not be available to all investors. Click here to view class A shares. Learn more about our active income solutions. Contact Delaware Funds by Macquarie to help you find opportunities that matter for your clients. Political uncertainty, regulatory change, new technology and even Mother Nature can introduce volatility to the markets and make the path to growth a risky one.
A focus on growth can help you amplify hard earned savings, help fund your future goals — like retirement — and even help you stay ahead of inflation, which can erode your purchasing power over time, no matter what investment vehicle you choose to use.
Historically, a strong correlation has existed between emerging markets and commodities returns. A decoupling has occurred in recent years, read more with a gap that continues to widen. While commodity correlation still exists in emerging markets, especially in energy-rich countries such as Brazil and Russia, the divergence between the two major indices shows that there are other meaningful drivers of performance in these countries.
Investors may be able to take advantage of new opportunities that arise from the structural shifts in these developing markets. Returns of US versus non-US developed stocks have historically swapped roles as performance leaders. Currently, we are experiencing the longest upcycle for US equity returns versus their non-US counterparts over the past 34 years. Shifting to international equity stock exposures may provide run-up portfolio diversification and potentially allow you to capitalize on changes in global equity markets.
Morningstar, as of Feb. The US small-cap market tends to be less efficient than other equities — which in turn can give active managers numerous opportunities to capitalize on. Add to that, fewer analysts cover small-caps and generate research, and the small-cap market is less homogenous than other equity segments, making it potentially opportunistic ground for active managers. Delaware Emerging Markets Fund.
Investment approach geared towards long-term structural growth opportunities — focus on companies versus countries. Learn more about our active growth solutions. The recession of upended many of the presumptions investors had about the markets and the path to investing success.
The experience of all investors has put emphasis on managing risk for investors large and small. Smoothing out investment returns by reducing portfolio volatility provides a means to stronger investment returns in the long run. Learn more about our active protection solutions. The Bloomberg Barclays Municipal Bond Index measures the total return performance of the long-term, investment grade tax-exempt bond market. Investment grade corporate bonds: All bonds in the index have at least one year to maturity.
The Bloomberg Barclays Emerging Markets USD Aggregate Index is a flagship hard currency emerging markets debt benchmark that includes fixed-rate and floating-rate US dollar-denominated debt from sovereign, quasi-sovereign, and corporate emerging market issuers.
Indices are unmanaged and one cannot invest directly in an index. Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held may be prepaid prior to maturity, potentially forcing the fixed income securities or bond funds to reinvest that money at a lower interest rate. High yielding, non-investment-grade bonds junk bonds involve higher risk than investment grade bonds.
The high yield secondary market is particularly susceptible to liquidity problems when institutional investors, such as mutual funds and certain other financial institutions, temporarily stop buying bonds for regulatory, financial, or other reasons.