The traditional buy, hold and rebalance approach to portfolio management typically comes under fire during periods of market duress, but a recently released paper confirms the notion that long-term investors have an edge versus short-term investors.
For the purposes of the paper, Investing for the Long Run (Ang and Kjaer, November, 2011), a long-term investor is simply someone with little or no specific short-term liabilities or demands for liquidity relative to the amount of capital invested. Translation for retail investors: you shouldn't need to touch the money in your portfolio for at least 10 years.
One of the main advantages cited in the paper is that long-term investors are supposed to have the ability to ride out short-term fluctuations. In practice, it can be a very difficult thing to do when stock market returns make the headlines daily.
A prudent long-term portfolio has but a few simple rules: 1) multi-level diversification, 2) rebalance, 3) don’t take on risk you can't stomach, and 4) keep fees low. Multi-level diversification means you diversify not only by holding many securities within the same asset class but also many different asset classes. But as simple as that sounds, even the professionals can’t always stick to the plan.
A example cited in the paper involves The California Public Employees' Retirement System (CalPERS), one of the largest pension funds in the world. It had an exposure to equities of 70 per cent of its portfolio in 2007. One year later and market performance brought that allocation down to 52 per cent. But then CalPERS sold off more equities in the portfolio because they needed to raise cash, and that brought their equity allocation even lower, to 44 per cent. They need for cash forced them from being long-term investors to being short-term investors. Instead of rebalancing to boost their equity allocation back to 70 per cent, they had to sell off more stocks and that hurt their future performance.
In 2008 as part of their moves, they sold a $370-million worth of shares in Apple . Had they held onto that stake, it would be worth around $900-million today. That would be even more if they had rebalanced back to the original plan, which would have entailed buying more stock, not selling it.
It should be of little surprise to find out that CalPERS has a new chief investment officer. Their situation shows just detrimental it can be to switch strategies mid-stream. So, if you've been making changes to your investment strategies on the fly, it might not be the plan that's not working. It might be you not working the plan.