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There is No Forever in Portfolio Management

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The image above is adapted from an article Barry Ritholz wrote in 2012 that discussed Forbes Magazine’s forever portfolio – in a Forbes article from 2000, they postulated that you could buy the ten stocks in the list using a buy and hold strategy for at least a decade.

As you can see from the list, only one of the companies stock price is actually higher than it was in 2000 (Viacom) while there are two bankruptcies and two takeovers at prices well below the 2000 prices.

The point of this exercise is to think about what active portfolio management gets you. A portfolio manager’s job is to review the holdings in a portfolio and ensure that the companies in the portfolio are operating efficiently and effectively.

With a buy and hold strategy like described by Forbes, what you risk is that while you are not watching your holdings, the companies can deteriorate and under-perform (or worse as four of the above did).

Another strategy that gets a lot of play as anti-active management is indexing. Indexing can be a fine strategy if you simply want to aim for average. Take a look at the graph of the S&P 500 below:


This is a graph that shows a 13 year view of the index, from April 2000 to April 2013. The index returned exactly 0% during that 13 year period of time.

It has performed very will recently, and there are always periods of time when indexing outperforms active management due to the structure of how the index is weighted. Apple being the largest company has the biggest impact on the performance of the index as you can see in the graph below that shows Apple and the S&P 500 Index plotted together:


Also positively impacting indexing the past couple of years has been the easy money policy of the Federal Reserve called Quantitative Easing which credited the big investment banks with newly created money for the purchase of bonds. These investment banks purchased billions of dollars of S&P futures contracts, moving the companies in the index higher. One statistic shows that the 50 largest companies in the S&P 500 have accounted for nearly all of the index’s performance over the past couple of years.

As we move into 2015, the Fed’s QE activities are ending and they are contemplating raising interest rates. Those forces will act in the opposite manner as the easy money forces acted, putting pressure on the index. Also of concern is that Apple’s comparative numbers in 2015 will be difficult because of the complete revamp of the iphone in 2014 and its huge impact on 2014 earnings. Apple also has no similar revamp of its ipad line planned, so it will likely not have the huge impact on the index that its had recently.

Active portfolio management will be increasingly important as the next stage in this market cycle unfolds – corporate earnings growth and valuation will again matter, making stock picking based upon those factors critical to portfolio returns while portfolio managers that rely on indexing for their returns will likely be losing their cool.

As we move into 2015, I will begin to share with you some of our analysis that shows companies we like because of their earnings and valuations. Until then, enjoy this video from REM that plays upon the South’s colloquial version of losing your cool.