Cheap and Simple Beats Expensive and Complex
Have a look at the tables below showing the performance of various investments during the five years leading up to the financial crisis lows, and the five years after. It leads us to a rather fascinating exercise, looking at complexity, cost and performance.
Let's start with the worst performers pre-crash: U.S. real estate and equities. In the period from March 2003 to October 2007, stocks almost doubled. Note that doubling began just three years after the tech and dot-com implosion. The peak to trough collapse of the Standard & Poor's 500 Index is even worse than that five-year track record suggests, falling 57 percent in about a year and a half ended in March 2009.
The real estate collapse was even worse: Off 58 percent in that five-year period. Perhaps some context might help. Residential real estate was little changed in real terms from 1986-1996, before rising in the late 1990s and then exploding from 2001-06. Vacancy rates for office space in the 1990s were near zero; shopping malls were getting built and sold off to investment funds as soon as they opened. Commercial real estate boomed in the 1980s, 1990s and early 2000s as real returns on fixed income was falling. The return on investment for commercial real estate -- and the low cost of capital -- attracted lots of buyers looking for alternatives to low bond yields.
The best performers leading up to the lows were managed futures and hedge funds. We've addressed hedge fund under-performance before. Surprisingly, despite screaming rallies in the 2000s in oil, food, gold and other commodities, managed futures only rose 26 percent during that five-year period. Given the 400 percent rally in gold, and the 500 percent in oil, one would have expected a greater return for this investment category. The costs, commissions and complexity of managed futures exert an enormous drag on their total performance. In that way, they are not too different from hedge funds.
Following the collapse, the worst became best. Valuations on equities never reached dirt-cheap levels, but they were certainly reasonable in 2009. Real estate also became more attractive. Those who came through the collapse with their capital intact were able to go on a shopping spree, sending real estate up 204 percent. To get to breakeven following a 50 percent fall (obviously) requires a 100 percent price increase. Real estate managed to garner real net gains beyond getting to breakeven.
U.S. and international stocks did well also, up 175 percent and 80 percent, respectively. Note that international stocks include a horrific run in emerging- market shares (the current bane of my portfolio), with Brazil, Russia and China all doing terribly. Somewhat surprisingly, Europe is the bright spot, propping up international shares as a class.
As always, there are caveats: Major events, such as a credit crisis, may not depict how these investments perform over other longer periods of time; and, as we have seen with some investments (namely hedge funds), a few outliers can continue to do very well even as the class underperforms.
But the take away to a real-estate-owning-asset-allocator-stock-jockey like me is this: If you have a long enough timeline -- a decade or more -- simple beats complex, and low cost trumps expensive. Land and equities are likely to be the investments whose returns surpass everything else -- assuming you start buying when you are young enough and at advantageous valuations.
Perhaps that is the biggest takeaway from the past decade.
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Barry L Ritholtz at firstname.lastname@example.org
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