U.S. Equity Returns Lead The Way

Outside of managing SL Advisors and writing books I chair two investment committees for local non-profit organizations. In reviewing returns for the first half of 2013 for one of them I was surprised at how U.S.- centric investment returns have been this year. Our benchmark is 50% Developed Market Equities, 20% Emerging Market Equities, 20% Fixed income and 10% Cash or “Other” (if we have an inspired idea that doesn’t fit the other three). Sitting here focused on U.S. stocks which is what we do every day, it feels like a banner year. So the 4.1% return on our benchmark was weaker than I expected. The 14.3% return in U.S. stocks (Russell 3000) was substantially offset by the MSCI Emerging Equities Index (down 12%) and the Barclays Aggregate Bond Index (down 2.5%). Our allocation is appropriate for a long-lived investment portfolio, but it illustrates some of the pitfalls in conventional wisdom. In our own business we don’t invest in fixed income because the entire bond market has been distorted by the Fed’s Quantitative Easing. My upcoming book Bonds Are Not Forever; The Crisis Facing Fixed Income Investors explains why. Shunning bonds entirely is quite radical and was outside the remit for this endowment, although we’re at the lowest level permissible under its mandate. No bonds at all would have been better.

The conventional wisdom of owning emerging market equities has always struck us as poorly conceived. No doubt emerging markets are where the GDP growth is, but it doesn’t follow that high equity returns will follow. In addition, there are significant challenges in selecting securities in countries where U.S. corporate governance, shareholder rights and accounting standards rarely prevail. Once in New Delhi, I asked a senior regulator how many insider trading cases are typically prosecuted each year. “Oh, none. There is no insider trading in India” was his breezy if not very reassuring reply. Or put another way, if you’re going to invest in India you might want to align yourself with someone who embraces local customs.

U.S. multinationals also understand that growth in markets is in developing countries. Why not let Coca Cola (KO), Procter and Gamble (PG) or Mondelez (MDLZ) decide how much capital to allocate to each opportunity? Receive the returns on these companies’ emerging markets activities through the relative security of U.S. reporting standards. That’s always seemed to us a preferable way to invest globally – through companies that are themselves global. So far in 2013, it’s looking like the right approach.

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