Last week, a headline in the International Business Times grabbed my attention. It was entitled “Utah Public Pension Fund Audit Calls for Reconsidering Hedge Fund Investments.” In case the headline wasn’t unambiguous enough for you, it was basically yet another article talking about how hedge funds have underperformed and, well, “off with their heads!”
A recent independent audit of Utah’s $32 billion plan evidently revealed the following:
- Utah’s alternative investment portfolio has increased from 13% of fund assets in 2004 to 40% of fund assets in 2014.
- If Utah had maintained its (stock heavy) asset mix at 2004 levels, it would have gained an additional $1.35 billion over the past 10 years.
- Employees must now pay more out of pocket due to pension shortfalls. (Along with 90% of other state pension constitutents who did or did not invest similarly).
That’s it, Utah. We’re canceling Christmas.
Seriously, as we look back over the past 10 years, it is perhaps easy to be smug about the money one could have made. After all, it’s easy to predict the future now that you’ve already lived it. It may also be impossible to not think of the massive coulda shoulda woulda money left on the table by not going all in long the S&P 500 on March 9, 2009. After all, in the five years after the 2008 market debacle the S&P 500 has generated an eye-popping 17.94% annual return.
But after the latest bull market run, it’s important to remember that one can only make decisions based on the information available at the time. We don’t have a crystal ball, and the one in the rearview mirror doesn’t count. While one can generally state that the markets will make gains over time (the S&P 500 does generate 10-year gains over five percent 84% of the time, after all), it’s nearly impossible for anyone to say when those gains may come or how much one stands to profit.
Just for grins and giggles, let’s take a moment and enter the MJ WayBack Machine to travel back to 2004. I’ll even hum Outkast’s “Hey Ya!” to get you in the appropriate mood.
- In 2000, the S&P 500 had dropped -9.1%.
- In 2001, the S&P 500 had dropped another -11.89%.
- In 2002, the S&P 500 had dropped yet another -22.10%.
That’s not a pretty picture. In fact, based only on our recent experience, it is probably pretty easy to forget that two of the S&P 500’s only four losing 10-year periods just ended in 2008 and 2009. That’s right, fellow MJ Waybackers, it ain’t been that long ago since we saw a decade end in losses. And that’s exactly what Utah was living through in 2004.
In light of that particular scenario, does it seem THAT unusual that Utah’s investment pension staff might have thought a shift away from equities into hedged vehicles could have been, in fact, a good idea?
And that gamble initially paid off. According to the audit, the pension’s hedge fund positions offered protection against 2008’s market losses. Had the 2004 stock-heavy allocation still been in place at that time, the Utah’s pension would have lost an additional $436 million.
In fact, I’m betting the 2009 memo read quite a bit differently than the most recent audit, but I doubt many would take the other side of that trade.
However, in the wake of 2008’s losses, we’ve seen the S&P 500 generate almost historic gains. In fact, only 3 five-year periods eclipse the recent post-crisis 5-year annual returns: the five years following 1981 when the S&P 500 gained 19.87% (annualized); the period following 1953’s loss, the S&P 500 generated 5-year annualized gains of 22.30%; and after the Great Depression’s 1931 loss of -43.34%, the S&P 500 went on to gain 22.47% over the next five years.
So, yes, we’ve seen this "incredible gains after losses" movie three times before. But we’ve been to the theatre expecting to see this movie a whopping 24 times. And yes, the market gains have been almost unbeatable lately, but they also aren’t necessarily the norm.
And also consider this. The S&P 500 is an asset-weighted index. Apple (APL) makes up 4% of the index, and it was up roughly 63% over the last 12 months. That one stock is one of the only things that prevented a 1Q2015 S&P 500 loss. Eight of its other top 10 holdings were in the red. My point? This bull market could turn on a dime.
But I digress.
What I think we’re seeing with Utah (and a host of other investors, individual and institutional) is a classic case of budding FOMO. And the Fear of Missing Out is not generally a good investment strategy.
At the end of the day, did Utah (and any other investor who finds themselves in a similar position) make reasonable decisions based on the information they had at the time? Sure. Are others who jumped all in to the market rally now having a more rewarding experience than they are? You bet. Could the resultant FOMO potentially set investors up to become less sensitive to risk in their haste to “keep up”? Yup. Could that strategy eventually bite them in the ass? Uh yeah. And I’ll bet that will make for an interesting memo, too.
Sources: NovelInvestor.com, International Business Times, AdviceIQ.com
