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Looking Through the Lens of “The Martian”

One of my favorite movies of 2015 was “The Martian.” It combined science and determination with a good dose of humor. Interestingly, I think these elements are also present in a truly thoughtful investor. As such, “The Martian” provides a great metaphor for investing in 2015 and what we believe an investor needs to do to thrive in 2016 and beyond.

If you haven’t seen “The Martian,” it features Matt Damon as one of the first astronauts to visit Mars. Damon (as character Mark Watney) is separated from his fellow astronauts when a severe storm strikes. The rest of the crew flees the planet, assuming Watney is dead. Watney is left on Mars with years to wait for a possible rescue mission. What makes his situation even more excruciating (for both his character and us, as viewers) is that Watney has no idea whether the Earth-based team realizes he is still alive. And even if they do, it’s unclear how long it would take a team to return to Mars—or if they would have the resources to do so.

However, Watney is an unfailing optimist and a brilliant scientist. He is short on supplies so he starts from scratch and relies on his knowledge of science to save him. A calamity of errors befalls Watney, but with intelligence, determination and humor, he makes it through.

Most Challenging Year

If you were disappointed by your portfolio’s financial returns this past year, you were not alone. The year 2015 actually was one of the most difficult times to be an investor in over 70 years. None of the major global asset classes earned more than 2%: U.S. large-cap stocks were up slightly, global stocks were down slightly, and short-term and intermediate-term bonds were only up a smidgen. Commodities were off sharply.
Asset Class 2015 Return

U.S Large Companies (S&P 500) 1.4%
Int’l Large Companies (MSCI EAFE) (0.2%)
Short Term Bonds (BarCap 1 – 5 Year Corp/Gov’t) 1.0%
Interm. Term Bonds (BarCap Aggregate) 0.6%
Commodities (Bloomberg Commodity) (24.7%)

So how is Damon’s astronaut character similar to a good investor? Like good scientists, savvy investors should always question their own assumptions. During challenging financial times, we should ask: How would we build a portfolio if we were starting from scratch? Would we use the same asset classes, diversify globally, and/or hunt for bargains? At RegentAtlantic, we question our previous assumptions and look for answers with a very scientific approach.

Scientists start investigations with data–all the data they can reasonably find. In the investment world, we have about 90 years of good financial data and another 60 years of very good data on international diversification. In our investigations, we’ve looked at as much data as possible—emphasizing what we believe to be the best information, rather than just the data from the past few years.

Next, scientists formulate a hypothesis. In our case, the hypothesis would be a question: What factors are most important in determining market returns and the volatility of financial returns? The hypothesis would then be tested with experiments.

In reviewing the academic science of investing, there are three major themes (completed “experiments”) that emerge.

1. Risk and return are positively correlated. Seeking greater returns increase risk.
2. Buying investments at bargain prices has a long track record of increasing returns.
3. Diversification reduces risk.

Risk and Return are Positively Correlated

Robert Schiller, an economics professor at Yale University, has compiled 144 years’ worth of data demonstrating that stocks, while volatile, provide a great vehicle to increase wealth. Most investors are going to need an allocation of stocks to meet their long-term goals. However, stocks’ volatility should be tempered by adding fixed-income elements to a portfolio.

Bargain-Buying Increases Returns

There are 90 years of data demonstrating that, generally, buying stocks when they’re at bargain prices relative to the market can add more than 1% of annual returns to a portfolio. This buy-low, sell-high value strategy will go through time periods (like the past five years) when it occasionally delivers below-market returns. However, given a long enough time period, this strategy, we believe, still works.

Diversification Reduces Risk

Data for the last 60 years demonstrates that adding small stocks, foreign stocks, real estate and emerging-market stocks to a portfolio generally reduces the level of volatility or risk, and at the same time increases the portfolio’s return. This diversification strategy, like the value strategy, goes through time periods like the last five years when it delivers below-market returns. However, over longer time periods, diversification has generally outperformed with less risk.

The Human Factor

Historical data is a great tool, but we are investing for the future. So how do we know that what has worked in the past will work in the future?

The fundamental force behind both the value and diversification strategy is humans. Real people set prices in the market by buying and selling what they like. We, as humans, can often behave irrationally which can cause us to herd into investments driven by both our fear and our greed. This phenomenon often creates bubbles and depressions in prices.

In the long run, however, our more rational brains often start to take over and these bubbles and depressions even out over time. So the value and diversification strategies seek to take advantage of these short-term price fluctuations to add value and reduce risk in the long run.

Staying the Course

We know this has been a difficult time to be a thoughtful, scientific investor. Like Damon’s character in “The Martian,” it can be easy to discount or even forget your hard-earned knowledge when you hit challenging times. That can make it hard to stay the course in the short-run. However, like the determined, fictional astronaut Mark Watney, I’m very confident that in the long run we are constructing and managing your portfolio (akin to his Martian-created supplies) in the wisest possible manner. We’re tapping what we believe to be the very best of our investment-science knowledge to calmly move forward in today’s challenging financial landscape.

If you have any questions, concerns or would like a deeper dive into the process behind our portfolio construction, please contact your Wealth Advisor.

The source for all data in this article: Bloomberg

 

Important Disclosure Information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested.  Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic.  This article is current only as of the date on which it was sent.  The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic.  Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

The index returns shown above show the total return for various investment indices and include the impact of the reinvestment of dividends. A comparison to indices may not be a meaningful comparison. Comparisons to benchmarks have limitations because benchmarks have volatility and other material characteristics that may differ from the performance of a client’s portfolio. The investments in a client’s portfolio may differ substantially from the securities that comprise each index and are not intended to track the returns of any index. One cannot invest directly in an index, nor is any index representative of any client’s portfolio.  Actual client accounts will hold different securities than the ones included in each index. The index returns are gross of applicable account transaction, custodial, and investment management fees. The actual investment results would be reduced by such fees and any other expenses incurred as an investor.  Please below for definitions of the indexes used.

Indices Used:

S&P 500 – The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment. The price return of an index is a measure of the cap-weighted price movement of each constituent within the index.

MSCI EAFE – The MSCI Europe, Australia and Far East (EAFE) Index is a free float-adjusted market capitalization weighted that is designed to measure equity market performance in foreign developed markets.  The index represents about 85% of the market capitalization of developed markets outside of North America.

BarCap 1-5 Corp/Gov’t – This Index covers USD-denominated, investment-grade, fixed-rate, taxable securities sold by the treasury or by industrial, utility and financial issuers and whose maturity period is at least one year and but not more than five years. It includes publicly issued U.S. corporate and foreign debentures and secured notes that meet specified maturity, liquidity, and quality requirements.

BarCap Aggregate – A broad-based benchmark that measures the investment grade, U.S. dollar-donminated, fixed-rate taxable bond market, including Treasuries, government-rated and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS.  The index was created in 1986, with index history backfilled to January 1, 1976.

Bloomberg Commodity Index – The Bloomberg Commodity index is a broadly diversified index that allows investors to track commodity futures through a single, simple measure. The index is composed of futures contracts on physical commodities. The index is designed to minimize concentration in any one commodity or sector. It currently includes 19 commodity futures in five groups. No one commodity can comprise less than 2% or more than 15% of the index, and no group can represent more than 33% of the index (as of the annual reweightings of the components).