The Investment World According To Harold EvenskyAdvisor Perspectives
I had the bittersweet privilege of attending Harold Evensky’s final presentation on investing. Evensky, who is by far the most decorated member of the advisory industry, is retiring and plans no further public talks.
Evensky spoke on September 26 at Bob Veres’ Insiders Forum conference in San Diego.
Nominally, Evensky is the founder of the Florida-based registered investment advisor, Evensky, Foldes and Katz.
But he is much more than that.
As Veres noted in his introduction, the advisory industry is divided by two eras: pre-Harold and post-Harold. The pre-Harold era, which most of today’s practitioners would barely recognize, was characterized by planning practices that relied on now-obsolete rules of thumb and seat-of-the-pants instincts that lead to inferior outcomes for clients.
Evensky changed that.
Early in his career, Evensky delved deeply into the academic literature to identify what makes sense to practitioners. The post-Harold era builds upon that approach. Evensky is singularly responsible for driving the paradigm of research-based and carefully tested planning practices.
His final talk summarized his key insights, accumulated over several decades as a practitioner and curator of research.
Why it’s different this time
There is something significantly different today in the investment world, according to Evensky, and that is the equity risk premium, which he said will deliver investment returns lower than their historical averages. Evensky cited the Shiller CAPE ratio, which is 31.1 versus its historical average of 16.2.
“It’s a very expensive market,” he said.
When the Shiller CAPE is broken into deciles, the returns for the subsequent decades illustrate the correlation. “We’re up near the peak of CAPE ratios,” he said. But he also acknowledged that the CAPE’s predictive ability is only good at long horizons, like 10 years.
In low-return environments, Evensky said, expenses and taxes “mushroom in importance.” He showed data that expenses subtracted 1% from prospective returns and taxes, at a 20% effective rate, will subtract another 1.4%. Investors should optimistically expect returns of 2%, net of expenses, taxes and inflation, he said.
Practitioners need to be thinking in a “three-dimensional world,” Evensky said, focused on expenses, taxes and inflation.
The core-satellite approach
Tax efficiency and manager turnover are correlated, according to Evensky. As trading activity increases, you lose all ability to manage taxes. Advisors should concentrate their core portfolios on funds that are very tax-sensitive, and concentrate their risk in “go-go” managers who are active.
If a manager cuts turnover from 100% to 50%, the marginal reduction in taxes is negligible, Evensky said. Managers need to be closer to 10% turnover to be thought of as tax-efficient.
That is among the observations that led to the core-satellite approach, which Evensky pioneered and popularized. It is a bifurcated approach that concentrates risk in the satellite portion, while the base investments are held in “beta-plus” conservative assets. Around the perimeter of the core is where advisors should look for alpha, Evensky said.
For him the core is 100% passive, with ETFs and index funds. Evensky also uses funds from Dimensional Fund Advisors in core portolios.
Modern portfolio theory is dead?
During the great financial crisis, many observers thought modern portfolio theory (MPT) was dead.
The problem, Evensky said, is that many of those pundits never read Markowitz, whose principal contribution was that risk is proportional to prospective return. Markowitz never said you should look solely at historical returns; investors need to look to the future at expected returns and covariance.
“The criticism of MPT is simply coming from those who never read the paper,” he said. “The problem is with the implementation, not the concept.”
Read the full article here by Robert Huebscher, Advisor Perspectives