Jean-Marie Eveillard On Benchmark TyrannyVW Staff
This article was written by conference speaker Jean-Marie Eveillard back in the early 2000’s on the subject of “benchmark tyranny”. He writes about how both closet indexing and shooting for the stars are exposing financial planners’ clients to undue risk: “In a recent issue of Barron’s, a money manager was quite critical of a particular stock, but said he owned it, although he was “underweighted”. Which leads to the question: what’s the point of holding a stock at all if one deems it unattractive? A portfolio that includes many stocks just because they have a big weight in the index (a result of their having gone up a lot) may go down sharply and still carry risk – no cushion there to begin with…An investor who buys a building or an entire corporation gives a great deal of attention to the price to be paid for the asset. So does the buyer of a car or even a bathing suit. They all seek value. What’s so different with equities?”
Jean-Marie Eveillard On Benchmark Tyranny (i)
In a recent issue of Barron’s, a money manager was quite critical of a particular stock, but said he owned it, although he was “underweighted”. Which leads to the question: what’s the point of holding a stock at all if one deems it unattractive? A portfolio that includes many stocks just because they have a big weight in the index (a result of their having gone up a lot) may go down sharply and still carry risk – no cushion there to begin with.
But that is precisely what many professional investors have been doing, in an attempt to match or modestly beat their “benchmark” over a short period of time. They do it instinctively, for self-preservation purposes, out of fear that assets would flee, bonuses be cut, or even jobs be lost if they failed. Is any attention being paid to the fiduciary duty to fund shareholders? If the fund were to go down 20% and the benchmark 25% would the managers be heroes? Or bums? More likely the latter in the eyes of the shareholders: “Whaddaya mean the fund is down only 20%!”
Other, bolder fund managers have played the “momentum” game with concentrated portfolio of fashionable names. They wish to beat their benchmark handily (and some have done so successfully). The question here: isn’t concentration a bull market phenomenon? Or, unless you’re as smart as Warren Buffett, shouldn’t you diversify? Isn’t diversification indeed a “raison d’être” of mutual funds? What are the risks inherent in a concentrated portfolio of “momentum stocks”? An investor who buys a building or an entire corporation gives a great deal of attention to the price to be paid for the asset. So does the buyer of a car or even a bathing suit. They all seek value. What’s so different with equities? Are they just pieces of paper to be traded in and out of on the basis of psychology, sentiment, herd instinct? Doesn’t financial history teach any lessons? After all, many individuals’ savings have been repeatedly wiped out (yes, wiped out) in the past half-century of economic expansion- most recently with internet stocks. My point here is: both closet indexing and shooting for the stars are exposing financial planners’ clients to undue risk. Both are a result of benchmark tyranny.
In contrast, I would submit that a diversified portfolio of securities, with no concern whatsoever for “underweighting” anything, should theoretically appeal to most planners’ clients. Diversification reduces risk, and neglect of “underweighting” keeps the portfolio away from vastly overvalued securities. I have made my own mistakes (more than I care to remember) but, in 1988-89, we owned practically no Japanese stocks (at a time when Tokyo had an even bigger weight than the U.S. in the world index) however we thought the entire universe of Japanese securities was outrageously expensive.
So what then should planners’ and their clients’ expectations be? Above all, I believe, after-tax returns somewhat in excess (note the precision…..) of Treasury bills’. In excess, of course, because the client’s money is exposed to equity risk. Second, returns that over a long period of time (not quarters of course, or years, but decades) are above an appropriate benchmark. Otherwise, why not index?
Most planners’ clients, I believe, are not (or should not be) trying to get rich or to save less through their investments. They are attempting to insure, as much as possible, that the money will be there to finance education for children or their own retirement. That is not “play money”, but “serious money”, so risk should be minimized. And if, as a result, the returns are not “off the charts”, they should save accordingly.
To some planners, what I’m saying here makes no sense. To others, it flies in the face of clients’ expectations today. So be it.
Up until several years ago, planners were saying to me: “We appreciate your returns but most of all we like your cautious, diversified, value approach because we know from experience that the best way to lose a client is to have him or her lose money in absolute terms.” Today, some say: “We still like your approach and your returns have been OK in absolute terms, but our clients all have a parent, a friend, a neighbor with aggressive growth funds that have done so much better than your funds. So there is envy.” Well, so be it too. We have had – for more than twenty years – preservation of capital as our first priority, and we’re not about to change. To begin with, we don’t intend to betray the patient souls who have stuck with us, presumably because they are in agreement with our approach and our execution.
I hear that some planners’ clients have become restless. A few want action: “Don’t just stand there – do something.” To which one may reply that Warren Buffett most of the time “does nothing” except hold on to carefully selected securities. A few – emboldened by the bull market and by the plethora of information (but information is not knowledge) have taken to picking stocks themselves (“Hey, who needs a planner?”). After so many great years in the market (twenty-five and counting – a generation), extrapolation is only human. But you and I know that left to their own devices, the great majority of individuals are terrible investors. Some, for sure, have the time, the inclination, the skills to do it themselves, but they’re a tiny few. The others will be back when (not if) risk is again a frightening word.
In sum, meeting or beating their benchmarks occupies the minds of most fund managers today. To the ultimate detriment, I believe, of your clients’ best interests. At times, it is hard, or even impossible, to show a client where his or her best interests lie. At times, the client is his or her own worst enemy. But planners should be aware that when the tide turns, as it will, tons of “serious money” may be lost. Benchmarks – stenchmarks.
(i) A shorter version of the piece was published in Financial Planning magazine in November 2000.