The Pitfalls of Maximizing Shareholder Value

According to Ibbotson data, the US stock market has delivered a 10.1% annualized return from 1926 to 2014. I mention this data, which includes two significant market corrections, because the numbers speak for themselves. The US entrepreneurial spirit, along with a vibrant capital markets system, is alive and well. We see this today in the slew of new technology startups, healthy corporate profits even in the face of a strong dollar, and record foreign investments in US companies. That being said, there’s something I believe investors have gotten wrong, and that’s the virtually unquestioned tenet that a company’s main responsibility is to maximize shareholder value.

This seemingly obvious truth is surprisingly, a new idea, conjured up in the early 1970’s by economist Milton Friedman who wrote a scathing rebuke of corporate social responsibility in an op-ed piece for the New York Times Magazine. Shortly thereafter, two business school professors ran with the notion and published multiple journal articles extolling the virtues of maximizing shareholder profits. The idea stuck and today most in the financial industry agree that this is the primary, if not only, responsibility of a corporation.

Perhaps because I started out as a high school science teacher, followed by a stint at a local zoo, I came to my first financial position at an institutional money management firm with a slightly different perspective. My first year as a stock analyst was confusing. I quickly learned that companies reported two sets of financial data, one based on GAAP or Generally Accepted Accounting Principles, and another set called “pro forma” that excluded a lot of recurring “one-time” expenses. Then I realized that while my Chartered Financial Analyst (CFA) studies helped me gauge the health of a company and its growth prospects (among other things), it became clear that the stock market game had more to do with beating Wall Street’s expectations for the upcoming quarter.

What was going on? Roger Martin in his book titled “Fixing the Game” suggests that a misguided focus on maximizing shareholder returns is incenting companies to boost earnings per share in the near-term at the cost of important, and often uncomfortable, investment decisions for the long-term. He notes that executive compensation is now more closely tied to stock and earnings per share (EPS) performance than ever before. This might be one reason why companies in the S&P 500 Index bought back shares at almost record levels in 2014. While reducing a company’s share-count provides a short-term boost to EPS growth, it leaves less cash on a company’s balance sheet for the critical business investments needed to drive shareholder value for the long-term.

So if maximizing shareholder value is not what company management teams should focus on, then what is? As with most pursuits in life, I find that fixating on a certain result often ends badly. No one can know the future, let alone deliver a certain outcome in perpetuity. Sure we can do it here and there in the short run, but in the grand scheme of things, our jobs – as individuals and companies – is to serve our clients and our communities. I believe that when companies focus on their customers, their employees, and their vision for the future, they are much more likely to maximize shareholder value – with the added benefit of contributing to society along the way. But when management teams and investors alike focus on profits for the sake of profits, the whole system becomes twisted and warped. We’re seeing this today in the rampant short-termism on Wall Street, outsized executive compensation packages, and subpar business investment levels – the lifeblood of our economy and capital markets.

While all this may sound discouraging, the good news is that more and more well-regarded financial professionals – among them, Warren Buffet, Jack Welch, and Blackrock’s CEO, Laurence Fin – are speaking up. One of our industry’s leading organizations, the CFA Institute, hosted a distinguished investment professional at its latest annual event whose presentation was called, “Shareholder Value Maximization: The World’s Dumbest Idea?” His research found that companies that focused on responsibility to customers, employees, and communities tended to outperform those that did not. All this to say that investors are starting to wake up the outdated and erroneous notion that corporations exist only to maximize shareholder value. We’re finally starting to put the cart back behind the horse, where it belongs.

Carrie A. Tallman, CFA
Director of Research


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Economic Predictions and Investment Decisions

The economy is an important factor that drives both capital markets and personal financial decisions. While we continuously monitor the latest economic news, have an opinion about the direction of markets, and incorporate these factors into our stock selection process, market or economic predictions do not drive us to make tactical shifts in your portfolio allocation.

We often hear, “What do you think the market will do this year?”

After a hefty caveat that the future is unknowable, and short-term market predictions can be hazardous to your wealth, we usually talk about the current economy, how it might affect markets in the near-term, and then provide a more intermediate-term view of the health of the U.S. and global economies.

Our investment philosophy hinges on the abiding belief that an investor should not attempt to time the market. That’s to say that an investor should not move his or her money in and out of asset classes based on economic predictions, or beliefs about what the market may do over the next few years. Rather, when we make decisions in a client’s portfolio, it is based on two factors: 1) asset allocation – based on the client’s financial goals and risk tolerance; and 2) individual security selection – used to comprise the contents of the asset classes that have been prescribed for the portfolio.

An investor’s asset allocation, if chosen correctly, shouldn’t fluctuate based on changes in the economic landscape. Instead, asset allocation should be reviewed regularly and modified if the individual’s financial situation changes. It’s the second of these two – security selection – where a bit more prognostication comes in. To be sure, we are fundamental analysts. We look at a company’s earnings, growth potential, balance sheet and cash flows relative to its price to determine whether or not the stock represents a good buying opportunity. Understanding the economy helps us understand those companies better. It helps us determine what the growth drivers of a certain sector may be, and what the consumer trends may look like for a given company. Understanding the economy is a critical component of our stock selection process.


Our Chief Economist, James F. Smith, provides insight to Parsec’s clients regarding the local, national and global economy. We appreciate Jim’s experience and perspective on economic matters, and we believe our clients enjoy getting to know him at various engagements, and of course hearing his entertaining, plain-spoken and informative economic speeches.

Recently, Jim was featured in an Asheville Citizen-Times article called “The Wisdom of Mr. Smith” about his success predicting housing prices. Way to go Jim! You can read that article here:

While economic predictions don’t drive us to make tactical shifts in our portfolio allocation, economic factors do play an ongoing role in our security selection process. To see Jim’s economic commentary each quarter be sure to read our newsletters. Back copies can be found here:

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Shouldering the Burden of Financial Responsibility

“Atlas through hard constraint upholds the wide heaven with unwearying head and arms.” –Hesiod

My Wednesday morning started with five 400-meter runs, uphill, carrying a 35# sandbag. OK, maybe “run” is a bit of an exaggeration – it was more of a trudge, and there might have been some walking in there toward the top. I hated every second of it, but I kept going because, well, that’s just what you do. When I thought about it later, it struck me as an apt metaphor for the way life feels sometimes – an endless uphill struggle with the weight of responsibility resting heavily on your shoulders. This is particularly true for anyone who is the primary provider for their family. As my colleague Carrie pointed out in her recent blog post, more and more women (including me) are finding themselves in this position, whether by choice or necessity. Most of the time I am able to face each day as it comes and maintain an upbeat outlook on life, but sometimes the enormity of this responsibility is paralyzing and my mind races with worries – what if something happens to me? Have I prepared for the worst possible outcome? What more can I do to ensure that the people who depend on me to keep going will be OK if I can’t?

Since everyone loves a list, let’s break this down into 5 areas that you definitely want to address if you are the primary provider for your family:

  1. Life Insurance – This one is pretty obvious, and I hope most people have some amount of life insurance in order to provide for their dependents should the worst come to pass. But do you have enough? Many companies provide life insurance as an employee benefit, but the standard amount will probably not be enough to replace your salary for an extended time. As a starting point, consider your current salary and how old your children are, so you can estimate how much financial support they will need and for how long. Beyond that, you may want to provide your spouse with your lost income until retirement age. Take these factors into consideration when determining the length of the term and amount of coverage you need.
  2. Long Term Disability Insurance – This one is a little less common, but no less important than life insurance. Think of it this way – if you become disabled and cannot perform the job that supports your family, how will you replace your income? What if your disability adds to the household expenses in the form of ongoing medical care? Now you’ve not only lost your earning power, but you’ve also become a liability to the family you once supported. Don’t let that happen.
  3. Estate Planning/Will – Many times younger people who are still in the asset accumulation phase tend to put off drafting a will, despite its importance. It is especially imperative if you have young children, since it allows you to determine who will become their guardian if both you and your spouse are gone. Make sure your beneficiary designations are up-to-date for any IRAs, 401(k) plans, pension plans or life insurance policies. For more complex estate planning strategies you might want a trust – your financial advisor can help you figure out what you need to do to make sure your estate plan is sufficient.
  4. Retirement Savings – If the worst doesn’t happen and you live to a ripe, old age, you need to be sure that you are saving money to provide for your golden years. As the primary earner, the bulk of this responsibility falls to you to contribute to your company’s 401(k) or another retirement plan, but it is equally important to include your spouse in your retirement projections and contribute to a plan for him or her if you can. Again, your advisor can help you figure out how much you need to be putting aside and how to navigate the ever-complicated IRS rules and requirements for retirement savings.
  5. Education Savings – Though not as imperative as the first four points, saving for your children’s education expenses will relieve them of significant financial pressure when they are in school and will help them avoid taking on massive amounts of student loan debt. You can rest easier knowing that if you predecease your spouse and children, you won’t be leaving them with an insurmountable tuition bill. As with retirement plans, there are several investment vehicles available to you for education savings. Work with your advisor to determine the best plan for you and your family.

Shouldering the burden of financial responsibility can make you feel like Atlas, but it needn’t crush you. With a little planning and preparation, you can weather the uphills, savor the downhills, put down the sandbag every once in a while and live fully in the present.

Sarah DerGarabedian, CFA Financial Advisor


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Why Not Use Margin?

Recent data indicate that margin debt has increased significantly over the past 12 years, although it is currently below the peak levels seen in 2000 and early 2014.

Margin is a feature that you can add to a taxable (non-IRA) brokerage account that enables you to borrow money against the value of your investments in the account. Initial margin, or the amount that you can borrow, is generally 50% of the value of the account. On a $100,000 account, you could borrow up to $50,000. The money can be used to buy more investments, or it can be taken out of the account and used for some other purpose.

Say you have an account that contains $100,000 in stocks. You write a check for $50,000 to purchase a new car. You still have stocks worth $100,000 in the account, but you owe the brokerage firm $50,000. Your net equity in the account is $50,000 (the $100,000 market value of your investments minus the $50,000 you owe).

Maintenance margin is the level of net equity which must be maintained in the account. If the equity in the account falls below this level, usually 30% of the account value, then a deposit must be made to the account or investments will be sold to reduce the margin loan balance.

Say the stock market experiences a correction and falls 15%. Your $100,000 in stocks are now worth $85,000. However, you still owe $50,000 to the broker. Your equity in the account is $35,000, or 41%. If the stock market continues to decline and your equity falls below 30%, some or all of your investments will be liquidated by the broker to reduce your margin loan. This is not good timing because you are being forced to sell stocks when they are down.

There are several other disadvantages to borrowing on margin that investors should be aware of. Interest rates are high; particularly when you consider that the lender is fully secured. Currently, the interest rates at major custodians are in the 5.5%-8% range, depending on the amount borrowed. Also, the interest rates are floating, so there is no protection against rising rates. Tax deductibility of margin interest is complex and more restrictive than other interest deductions such as on your home mortgage.

Using margin always increases your portfolio risk, particularly if you use the proceeds to buy more stock. Let’s go back to the previous example of the $100,000 account, but this time you take a $50,000 margin loan and use it to increase your stock holdings. You now have $150,000 in stock and owe the broker $50,000. Your net equity is $100,000. Say the stock market falls 20%; your stocks are now worth $120,000. You still owe $50,000 to the broker, and you’ve lost 20% of 150,000 instead of 20% of 100,000. In other words you have a $30,000 loss instead of a $20,000 loss. You’ve lost 30% of your initial $100,000 on a 20% market decline. Your loss was 1.5 times that of the overall market, plus you paid interest on the margin loan. Not a good outcome.

There are some situations where margin can be appropriate, say for short- term needs where the amount borrowed is a small percentage of the account value. We generally advise against using margin on a longer term basis.

Bill Hansen, CFA

Managing Partner


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Gift Stock Yields Better Returns Than Gift Checks

 This article was originally published on

When thinking of giving a gift, most people immediately consider writing a check, giving a gift card to a favorite restaurant, or ordering something online.

However, from a financial planning perspective, this is a very inefficient method of giving. Unfortunately, the method that gets you the biggest bang for your buck is usually the most complex, impersonal and inconvenient, as is often the case in financial planning.

Let’s take a look at a few ways to get a little more “bang for your buck” with a gift.

Consider what the alternatives to giving cash might be. It is pretty hard to think of ways to give a gift without using cash.

One way to do so is to gift stock, preferably appreciated stock. It is very common for the individual giving (grantor) to be in a higher tax bracket than the individual receiving the gift (grantee). For this reason, the grantor is able to give more to the grantee because they don’t have to sell the stock, pay the taxes, then give the cash. To make the situation even better, the grantee may not even have to pay taxes when they sell the stock, if they are in the 0% to 15% tax bracket. This isn’t your traditional heart-warming gift from Grandmother, but the tax savings sure are heart-warming to me.

Another play on the same technique is to gift appreciated stock to young children in a custodial account. This allows either the grantor or a parent to act as a custodian over the account until the child reaches age 18 or 21, depending on state law. Appreciated stock can be directed into this account and sold over time with minimal tax consequences. However, you have to be aware of the “Kiddie Tax” for unearned income over $2,000 attributed to the child. Any amount over $2,000 is then taxed at the parents’ highest tax bracket! To extend this gifting strategy, cash produced by dividends and sales from this account can be transferred to a 529 savings plan in the name of the beneficiary. Just don’t forget to give the child something useful or fun at the same time.

Although these techniques are not as easy and straightforward as writing that check, there are some significant tax savings available for those who choose to use them. For individuals who are trying to play catch up on funding 529 plans or gifting to children or grandchildren, the annual gifting limit is $14,000 per year per person for 2014 and 2015.

Daniel Johnson, III CFP®

Financial Advisor


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Call Me….Maybe

I recently saw an article titled, “Use Puts and Calls to Finance Your Holiday Gift Shopping.” It proceeds to explain how you can employ certain options strategies (shorting puts and covered calls), to generate portfolio income – in this case, a little extra cash for purchasing holiday gifts.

“My Parsec advisor hasn’t suggested this to me,” you think. In fact, your Parsec advisor hasn’t suggested any options or derivatives strategy to you! What gives? Aren’t we supposed to be looking out for our clients’ best interests?

Yes, we are. And that is why we typically won’t suggest such a strategy to you. Not that there is anything wrong with it, per se, but most derivatives strategies are short-term in nature, and one of our main tenets is investing for the long-term.

Even though the author of this article is suggesting relatively safe (rather than speculative) strategies, there is risk involved, and the upside is limited. When you short (a.k.a. sell or write) a covered call, you give someone the option to purchase a stock that you own at a predetermined (strike) price, in exchange for payment (known as the option premium). Shorting (selling or writing) puts involves giving someone the option to sell you a particular stock at a predetermined price, also in exchange for a premium. If you enter into one of these contracts, you are obligated to either sell or buy the underlying stock if the owner exercises the option. If the option expires unexercised, you keep the premium without having to sell or buy the underlying.

The objective is to enter into contracts that you think are unlikely to be exercised based on your prediction of the underlying stock’s price movement, and earn income by pocketing the premium. Of course, there’s always the chance that the market will move in such a way that the owner will choose to exercise the option, and you will be forced to make a trade.

So let’s think about this – why would someone exercise a call option? Obviously because the market price has moved above the strike price and they can buy it for less, then turn around and sell it for a profit. So you’re selling a stock that’s going up (at a below-market price), and giving up any potential upside in that stock.

And why would someone exercise a put option? Because the current price of the underlying stock has dropped below the strike price, so they can sell it to you for more than it’s worth in the market. Even assuming that it’s a stock that you want to own, wouldn’t it be better to buy it at the lower market price? If you calculated the breakeven correctly, the premium earned on the option would offset the difference in strike and market price, but then you’re effectively at zero, having earned nothing (such as dividend income) in the interim.

Our philosophy is that the best results occur over a long time period, in portfolios consisting of a well-diversified array of carefully chosen, quality investments. We make buy and sell decisions based on in-depth research of underlying company fundamentals, rather than market predictions. In this way, we seek to avoid the pitfalls of human behavior and emotion, as well as the likelihood of inaccurate predictions. We like to be owners of companies with real earnings and dividends, and participate in long-term, profitable investments because this is how we help you attain your financial goals…such as a long, comfortable retirement as well as the perfect gift for everyone on your list.

Sarah DerGarabedian, CFA  Portfolio Manager


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Top 10 rules to a frugal life:

Those that know me well can vouch for the fact that I am a frugal person.  I feel that there is much that is virtuous about living a frugal life.  Learning about delayed gratification and the important limits to set upon our role in a consumption based economy is a great path to happiness and peace.  The famous economist and philosopher John Stuart Mill once said, “I have learned to seek my happiness by limiting my desires, rather than attempting to satisfy them.”  This simple phrase rings true to me.  This is especially evident as you stand witness to the constant bombardment of consumerism in our media and markets.  Take stock of what you have and the blessings of life and you might not fall prey to the treadmill of consumption that will always be tempting you.

Top 10 rules to a frugal life:

  1. Budget – know where your money goes.
  2. Be guarded against lifestyle inflation; try to keep income growing faster than expense growth.
  3. Don’t be wasteful. Consider gently used items when buying cars, and other depreciating assets.
  4. Find discounts whenever possible.
  5. Trips and vacations are about experiences, not necessarily lavish accommodations.
  6. Frugal people rarely eat out, preferring to prepare their own food.  I find it better and healthier, not to mention less costly.
  7. While there are many worthwhile private schools, there is a great value to be found in many of our public schools as well. Consider whether public schools, for both young children and college, may be right for your family.
  8. Frugal people care less about fads and trends; keeping up does not matter to them.
  9. Know the value of a dollar, if there is a lower interest rate find it.
  10. Don’t be cheap, stay generous.  It is ok to part with money to help others.

Richard Manske, CFP®                                                                                                                                      Managing Partner

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Required Rate of Return

Whenever I meet someone new and am asked the obligatory “what do you do?” I typically get two reactions. Roughly half of folks respond with an unconscious grimace and politely excuse themselves in search of someone more interesting.  The second reaction is one of delight and surprise.

Once this exchange happens with an interested party, the next question I usually get is – what stocks do you like? Now I’m the one grimacing.  The reason being is that stocks are as varied as the investors who own them.  In addition to first understanding an investor’s risk tolerance, time horizon, and long-term goals, picking stocks requires a lot of analysis.  One of the cornerstones of equity analysis begins with something called the required rate of return. If you’re not already grimacing, read on brave reader!

A required rate of return effectively measures what kind of payback you need to get in order to go forward with a stock (or any investment) purchase. To determine a stock’s required rate of return you need three inputs: (1) the economy’s real risk-free rate of return (2) the expected inflation rate and (3) a risk premium to make-up for the added uncertainty that comes with owning a stock.  The first input, the real risk-free rate of return is a return you can theoretically get today with virtually no risk.  We plan to own our stock for ten years, so we’ll use the 10 Yr Treasury bond as our risk-free rate proxy, currently yielding ~2.5%.  We start with the “risk-free” rate because if nothing else, the stock you’re considering should at least deliver a return on par with a very safe US Treasury bond.  And then some, because you need to be compensated for the additional risk you’re about to take.  More on that in a minute.

Next, rising costs will diminish the purchasing power of your dollar over time, so you’ll want to have an investment that at least offsets the deleterious effects of inflation. Expected inflation is currently running around 2%, so we’ll add that to our risk-free rate of 2.5% for a required stock return (so far) of 4.5%.  Finally, because of the added risk you take on by owning a stock, you should demand some kind of compensation for this uncertainty.  We account for this risk by taking a stock’s beta or its volatility compared to the market, and multiplying it by an equity risk premium.  The equity risk premium is generally estimated by subtracting the expected equity market return (stocks have returned 10% on average over the long-term*) from the risk-free rate.  Thus, our equity risk premium is 7.5% or 10% minus the risk-free 2.5%.  Phew.  Using a pretend stock, Widgets-R-Us (Ticker: WIGGY) as our prospective stock investment, with a 5-year beta of about 0.90 – meaning it has historically been less volatile than the market – we get a total risk component of 6.75% (beta x equity risk premium or 0.90 x 7.5%).  Putting it altogether we should require WIGGY to return at least 9.25% before wading in.

Congrats! You calculated a required rate of return.  Although this is an important starting point, I’m sorry to tell you it’s just the beginning.  It’s a good beginning because we now know what return we require in order to buy Widgets-R-Us, but you may have guessed that without an expected rate of return we don’t have a lot to go on.  The good news is that there are plenty of knowledgeable investment professionals who can do the work for you.  And importantly, are willing to take the time to explain how they come to their investment decisions.

*Ibbotson, large cap stocks 1926-2012

Carrie Tallman, CFA

Director of Research


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What is an Index (and why should you care)?

Recently I was on vacation with a friend, and while enjoying the sunshine she received a CNN alert…

Breaking News: Dow Jones Industrial Average soars to an all time high.

She then asked me what the Dow Jones was exactly … “Should I know what this means?” My response was, “it’s a stock market index, of course.” Seeing the perplexed look on her face, I realized that she had no idea what I was talking about. After having this conversation, I wanted to share with you what I shared with my friend.

  1. What is a market index? – A stock market index is simply a measurement of the value of the market or a section of the market. Let’s break it down into a simple example. Assume ABC index is made up of 6 companies. At the end of trading on Monday the index is at 5,000 points. On Tuesday, three of the companies go up in value, two of the companies go down and the sixth company stays the same. The total value of the stocks change by 3% on Tuesday, so now the index is at 5,150 points. This tells you that this section of the market went up in value from Monday to Tuesday.
  2. Why are market indexes important? Choosing appropriate investments is only the beginning. One of the biggest challenges of an investor is to determine how well your portfolio is performing. Are you lagging behind the market or beating it? You can only know the answer to these questions if you have something to compare your investments to. Indexes allow you to measure the performances of your investments against an appropriate benchmark.
  3. How do you choose the right benchmark? In general, when you are tracking the performance of an investment, you look at a benchmark that is most similar to your investment. For example: If your portfolio is all U.S. large cap stocks you would likely use the S&P 500 as your benchmark. If your portfolio is all fixed income then you would most likely benchmark against the Barclays Aggregate Bond index. If your portfolio is a combination of both large-cap stock and fixed income you would want to use a blended benchmark of the two indexes.
  4. All of this is for naught if you don’t know what indexes track which stocks. Here are some of the most common market indexes and the companies they are comprised of.
  • Dow Jones Industrial Average (DJIA) – This is one of the most popular measures of the market. A.K.A. “The Dow” or “Dow 30” is a price-weighted measure of 30 US blue-chip companies. The index covers all industries with the exception of transportation and utilities, which are covered by other Dow Jones indexes.
  • S&P 500 Index – This index is based on 500 U.S. large cap companies that have common stock listed on the NYSE or NASDAQ. These companies are representative of the industries in the U.S. economy.
  • Russell 2000 – This index tracks 2,000 small-company stocks. It serves as benchmark for the small-cap component of the overall market.
  • Dow Jones Wilshire 5000 – This index covers over 5,000 US companies listed on major stock exchanges. This includes US companies of all sizes across all industries.
  • Barclays Capital Aggregate Bond Index – This is a broad-based benchmark that measures the investment grade, US dollar-denominated fixed-rate taxable bond market.
  • MSCI EAFE Index – This index is designed to measure the equity market performance of developed markets outside of the U.S. and Canada. EAFE is an acronym that stands for Europe, Australasia and Far East. (Check out Sarah DerGarabedian’s blog post from last week to read why it’s important to have an international allocation –  
  1. It’s important to remember when comparing your investment returns to compare your results to the long-term market, not just the past year. Typically analysts look at 3, 5 and 10 year returns. Short-term results can often be misleading due to short-term volatility. A quick Google search should provide you with the long-term returns of any of the major indexes.

After explaining all of this information to my friend, I think she had a better grasp on market indexes and hopefully this information is helpful to you too. One realization that came from our conversation is that sometimes financial advisors (nerds) forget that things that seem so common to us aren’t as familiar to those not in the industry. We never want a client to leave a meeting or conversation feeling confused or uncertain. If you have questions, please ask! We may just write a blog post about it.

Ashley Woodring, CFP®

Financial Advisor




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Kit Kats, Blow Pops, and the Benefits of Diversification

“But international stocks are underperforming the S&P 500! Why are you buying international mutual funds in my account?”

We hear this question a lot. People often wonder why we include various sectors and asset classes in our portfolios, but the one that tends to get the most scrutiny is international equity. Many investors exhibit what is known as “home bias,” or the tendency to invest primarily in domestic securities, whether it stems from a nationalistic desire to “buy local” or simply the belief that international investing carries additional costs and complexities. Often, investors eschew international diversification to their detriment, as many studies have shown that the inclusion of international equities lowers portfolio volatility while increasing risk-adjusted return. However, these metrics are not what investors see – they see performance. They see that the return on their international fund is lower than the return on the S&P 500 and fear that it will be a drag on their returns forever. So why don’t we sell it?

Quite simply, we keep it for the diversification benefits. With Halloween just around the corner, perhaps an analogy will help. When you’re trick-or-treating, you knock on the door of every lighted house and collect as much candy as you can carry home. Then you dump it out on the floor and sort through it to revel in the spoils. Hopefully you’ll come home with lots of chocolate candy bars, M&Ms, Milk Duds, Junior Mints, and Reese’s cups. Then there might be a smattering of Smarties, Starburst, and Skittles, which are fine. Invariably there will be a few of those orange and black-wrapped peanut butter taffies, some chalky Dubble Bubble and a handful of Dum Dums – but that’s OK. A few crummy candies won’t ruin the night, since you have so much more of the good stuff. And you never know which houses are going to hand out what candy, so you have to hit them all. (And to the person handing out raisins, just stop. Don’t be that guy.)

Now imagine that your portfolio is a bag of Halloween candy. Even if you love Snickers, it would be pretty disappointing if your entire haul was nothing but Snickers – that would defeat the purpose of trick-or-treating, because you could simply go to the store and buy a bag. No, you want a wide variety from which to choose, based on changing moods and cravings! In a similar way, you need to diversify your investments so that the mood of the day doesn’t destroy your savings in one fell swoop. If your entire portfolio consists of the stock of one bank and the bank goes under, you lose all of your money. If you buy the stock of 5 different banks, but the entire banking industry hits a rough patch, your portfolio plummets…so you buy the stock of 40 different companies in different sectors and industries to spread the risk. But what if they’re all domestic companies and the domestic economy tanks? I think you see where this is going. Different investments zig and zag, moving in opposite directions simultaneously, which dampens the overall volatility of the portfolio.

You may not be a huge fan of Blow-Pops, but what happens if you fill your bag with Kit Kats and you’re suddenly in the mood for Sour Apple? What if you leave your bag in the sun and all the Kit Kats melt? It’s true that if particular sector (such as international equity) underperforms and you have it in your portfolio, you might get a lower return on your portfolio for that period. But when that sector rallies, you’ll be happy you had a couple of Blow-Pops in your bag.

Sarah DerGarabedian, CFA

Portfolio Manager


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