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2011 In the Rear View Mirror

If ever there was a year to ignore the Wall Street “experts,” 2011 may be one of the best. In a tumultuous year for equity markets across the globe, it was even more notable in that so many prognostications made a year ago were so off the mark.  Fortunately for our portfolios, Springboard doesn't make investment decisions based on conjecture and the bad advice of the “experts” didn't affect our clients.  Unfortunately, global economic turmoil affected world markets and those gyrations could not be side-stepped. 

Bonds – could they have been more wrong? Perhaps the most well-noted and public forecast of all was Meredith Whitney’s interview on 60 Minutes in December 2010 that warned us all of the impending doom that was the municipal bond market. Hearing her arguments, it was a compelling case to abandon ship and find other investment solutions. However, for 2011, the S&P National AMT-Free Municipal Bond Index was up a whopping 11.22% for the year! And munis were not alone in their exceptional performance. Notably, the DFA Inflation-Protected Securities fund (a core holding in Springboard’s portfolios) was up 14.54% for the same period. Our decision to stay firm on our portfolio holdings as we entered 2011 turned out to be quite prescient, and insulated our investors from some of the gloom of world equity markets. They certainly did their job as diversifiers and to counter equity risk, but there should be no expectation of this magnitude of performance going forward. 

Equities – all over the board As trite as it is to say, this year was quite the rollercoaster for equities. From peak to trough, the S&P was down nearly 18%, although it was a virtual break-even for the full year. But that’s not the whole story of US equities. The Dow Jones Industrial Average, an index comprised of only 30 stocks, managed to gain about 6% for the year. Therefore, I would expect the stock picker crowd to start their banter of how last year was an opportunity for active fund management. But that was not the way it played out.

Active money managers will tout their ability to outperform during volatile markets, but three of the most revered stock pickers of the modern era have seen their funds decimated by their bad calls. My go-to story on the pitfalls of active management is Bill Miller of the Legg Mason Value Trust. For one and one-half decades ending in 2005, he managed to annually beat the performance of his benchmark, the S&P 500. But then it all changed. In 2006, 2007 and 2008, his fund ranked in the 99th percentiles of his peer group each year – giving back every dime of outperformance of his tenure and then some. In 2010 he finished in the 98th percentile and last year (2011) ended up in the 76th. He recently announced his retirement from money management --no doubt giving the excuse that he wanted to “spend more time with his family.” 

But Mr. Miller is not alone in his position. Bruce Berkowitz manages the Fairholme fund and for his previous outstanding performance in money management, he was named Fund Manager of the Year for 2009 and Fund Manager of the Decade for the 2000s by Morningstar. So when his fund reached the top 1% of funds in his peer group last year, I’m willing to bet that a lot of investors (and advisors) decided they wanted a piece of this action. Little did they know that Mr. Berkowitz would be in the 99th percentile in 2011. If you think you’re disappointed in the S&P having barely broken even this year, how would you feel if you put money in Fairholme which was down over 32%? And my last case in point is the storied CGM Focus fund, managed by Ken Heebner -- another legendary money manager that backed his investors into a corner last year. This fund managed to end up in the 100th percentile of his peer group. That’s right, at the very bottom. No money manager can control the markets but an advisor’s job is to assist clients in reaching their goals. And one of the ways to do that is to avoid costly mistakes (some call it “winning by not losing”.)  Springboard's focus on low-cost, passive-oriented equity investments insulates our clients from these very unfortunate outcomes of active management gone awry. 

Global markets – the Achilles’ heel of diversified portfolios But aside from “experts” guiding us errantly, global markets did us no favors either. Morningstar’s Global Ex US Index was down 13.85% for 2011, and their Emerging Market Index was down over 17.4%. Some may believe that the “extra risk” of investing in international markets should keep us from investing overseas, however it would be unwise to concentrate our equity holdings into any one political and economic entity. As a matter of fact, in 2007, the US market (S&P 500) was up only 3.5% compared to Germany and Brazil up 22% and 44% respectively for the same period. Being absent international equities that year would have resulted in a lackluster year for growth. A well-designed portfolio with more “pistons” should perform with less volatility over time and the math still supports this theory. 

So what do we do now? History tells us repeatedly that what appears obvious is not always so when it comes to predicting markets. So our advice: don’t just do something – sit there! We’ve reviewed the portfolios and there is no evidence that suggests that a change to our strategy would either increase our long-term returns or reduce our risk (i.e. short-term volatility). Therefore, we (as we do regularly) will review the allocations of our clients, ensure that they are appropriate based on the goals we have set, and re-position as necessary. We are still pleased with our longer-term risk/return numbers and it is to be expected that not every cycle will hit on all cylinders. Long-term success will come through thoughtful discipline, use of low-cost investment tools, and regular rebalancing, self-analysis and review. As always, we appreciate your comments, questions and feedback and look forward to 2012. - Charles and Rebecca  Sources: Google Finance, Birinyi Associates, Morningstar.com