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Is the S&P really the best “default” place in which to invest assets?

Is the S&P really the best "default" place in which to invest assets? © everythingpossible via iStock

With over 60 years of combined experience in the markets, we have surely seen a number of trends come and go. Styles constantly come in and out of favor, but a real investment “discipline” is what endures.

Consider that it was only a few years ago when investors of all types, from the largest institutions to the smallest retail investors, were clamoring for alternative strategies. Today, some of those strategies are experiencing significant net redemptions.

Currently, the “chosen” strategy entails simply pouring your assets into the S&P 500 in any one of the many vehicles available for tracking that large-cap, growth-biased index. This bellwether index has achieved rockstar status by virtue of its performance, versus other strategies available in recent years. Some investors have therefore come to consider the S&P 500 an almost risk-free asset class that can be used as a default home for liquid assets.

Low volatility and every minor dip that seems like a buying opportunity can take credit for this perception. The S&P’s popularity has come at the expense of other investment strategies and asset classes. It further raises the question, “Has global diversification become obsolete for dollar-based investors?”

Investors for years have been taught that global diversification is part of any well-thought-out investment strategy. Interjecting the benefits of currency and geographic diversification into a portfolio has offered some attractive risk-reduction effects over the long term and during most market cycles.

The S&P’s popularity has come at the expense of other investment strategies and asset classes.

Lately, though, the S&P 500 has been at the top of the leader board over the past three years, versus other strategies.

You need to look back to 1995 through 1998 to see a period when the S&P was able to dominate other investment strategies. The years that followed saw the S&P 500 sink toward the bottom of the table, leaving those who chased that trend disappointed. That result was another instance of mean reversion among strategies, and the benefits of global diversification.

Almost every presentation on equity investing has some common threads that are part of the slide presentation that makes the case for allocating assets there. One such chart is known as the “Quilt.” That chart takes the annual returns of various recognized investment strategies and stack- ranks them based on returns.

As the years go by and every discipline takes its turn at the top and bottom of the return rankings, the chart resembles a patchwork quilt. It is that visual representation that makes one of the best cases for not abandoning the notion of global diversification for the sake of a concentrated position in what has been working lately. Today, that favored strategy is the S&P 500, and if history repeats, the S&P is headed to a few years of under-performance relative to other equally viable and recognized disciplines as the cycle grinds on.

The catalysts for the reversion may come from reversals in monetary policy or some bold fiscal measures in markets outside the United States. One thing we can be confident in is that there is nothing so terribly different about this cycle that the benefits of global diversification, including currency, have been rendered obsolete.

If you have been fortunate enough to have used the S&P as a default place to invest assets, consider yourself lucky; but recognize that expecting the next three years to resemble the last three could leave you disappointed with the results. Declaring victory on that investment and moving forward to a more diverse approach is still our best advice.

The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index.
Diversification does not guarantee a profit or protect against a loss.The strategies and/or investments referenced may not be suitable for all investors. Morgan Stanley Smith Barney LLC offers insurance products in conjunction with its licensed insurance agency affiliates.

Tony Maddalena, Wealth Advisor with the Wealth Management division of Morgan Stanley in Purchase, NY. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, member SIPC, www.sipc.org. Morgan Stanley Financial Advisors engage Worth to feature this article. Tony may only transact business in states where he is registered or excluded or exempted from registration, http:// fa.morganstanley.com/themaddalenagroup. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Tony is not registered or excluded or exempt from registration. CRC1558442 9/16

This article was originally published in the October/November 2016 issue of Worth.

Topics
Investing and the Economy

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