History Repeating: Are Equities Really Worth It?

(March 28, 2012)  —  Investors are becoming disillusioned with the performance of their equity portfolios, and questioning the validity of holding the relatively risky assets for little return, Russell Investments has said.

Since the start of this millennium, United States equities have risen 1.2% per year according to the Russell 3000 index, with international equities up only slightly more at 2.8% each year, shown by the MSCI World ex-US index.

On a dollar-invested basis – and with dividends reinvested – bonds fared better than both sets of equities.

A paper from Russell this week said: “As a result, disgruntled investors are questioning many of the traditional tenets of investing, including the role of equities, risk versus reward, and portfolio diversification.”

Given such poor returns in the immediate past, investors, who Russell warns are often prone to having short memories, may be tempted to move out of the asset class entirely.

However, portfolio diversification remains key to a healthy exposure across all return-seeing assets and good risk management, the investment consulting firm said. They said as investors had only moved into equities relatively recently, they should stick with them.

The paper, by Mike Smith, consulting director for Russell, showed how over each decade since the 1970s a different asset class, from a choice of US and international equities, bonds and a 60/40 balanced portfolio, was the outperformer.

Socio-political and other natural events were often the major impetus for the outperformance, Russell said, showing that investors should be amply diversified to avoid being hit too hard in any instance and being able to take advantage elsewhere.

The paper said: “Both international stocks and bonds did much better than US stocks over the last dozen years. Still, it is impossible to predict the future. Market leadership can change abruptly, catching most by surprise. However, we may win by diversifying into asset classes that may not look attractive on the surface.”

Addressing the question of whether investors should move out of equities due to their recent poor performance, Russell said the asset class still offered good return potential and investors who had finally accepted it as a mainstay of a portfolio in the 1980s should stick with it.

“In reality, it took the two strong decades of the 70’s and 80’s to get investors to consider them seriously. Now they are a portfolio fixture, and deserve to be, along with fixed income and other diversifiers.

The paper concluded: “Diversification does not assure a profit and does not protect against loss in declining markets.”

It said that diversification in a portfolio allowed for returns with relatively low volatility.

“Lower volatility enables investors to stick with their plans and not chase last year’s winners because they already have some of what won. In addition, they own some of what may win next year. That’s a portfolio that can work for your clients over their investment horizon.”