Why isn’t my Portfolio keeping pace with the Market?

Thomas BalisOctober 2, 2018

HFA News

Some of you may be wondering, why isn’t my portfolio keeping pace with the market?  We wanted to help answer that question.

Despite a turbulent summer fueled by concerns of trade skirmishes, a hard Brexit, political infighting, and rising interest rates, the stock market has trended upward, recently eclipsing the highs from January 2018.  Indeed, the S&P 500 (a broad measure of performance of large, US companies) closed at a record high of 2,930 on Friday (9/21/18), up 9.58% so far this year.

This may then beg the question, “If the market is up so much, why isn’t my portfolio?”  The answer comes down to one word: diversification. Most professionally managed investment portfolios, including those administered by HFA, are diversified across many asset and sub-asset classes.  These include stocks and bonds, domestic and international holdings, variations for size and style, and so on.    While the S&P 500 does track one of those categories, the reality is our portfolios track 14 additional indices in order to maximize diversification and risk adjusted return.

Every text book, research paper and historical analysis will tell you: “Don’t put all of your eggs in one basket. Diversify your portfolio.”  HFA has a very strict discipline in how we construct clients’ portfolios.   Research has long shown that over 90% of return variation is explained by asset allocation, with security selection and market timing playing only minor roles.[i]  This asset allocation mandate helps us to provide reasonable investment returns with a moderate level of risk.  Our investment management team continually completes extensive portfolio optimization analyses across all asset classes to achieve the appropriate asset allocation for our clients’ portfolios. 

Within our portfolios, we adhere to the following investment principles:

  1. Utilization of passive and active management where appropriate
  2. Asset allocation amongst all major asset classes
  3. Variance rebalancing when asset classes are out of line
  4. Monitoring of selected money manager performance on a daily basis
  5. Tax considerations built into every portfolio
  6. Avoidance of attempts to time the market with short term tactical moves

This year has been a more challenging one for investors.  Several of our asset classes have not performed per our expectations.  Let’s start with bonds.  As interest rates have increased, bond values have actually declined this year. With positive returns for nine of the last 10 years, the Barclays US Aggregate Bond Index (a broad measure of the bond market) is down nearly 2% for 2018; it hasn’t performed this poorly since the taper tantrum of 2013.  With rates remaining at unprecedented lows since the financial crisis, many have forgotten that in a normal market, bond returns are usually inversely correlated with equity returns.  This means when your stocks are up, your bonds normally would be down.  Fortunately, HFA uses only investment grade bond funds in our portfolios, so the declines are modest, indeed.  When equity markets decline, (as they invariably do), we count on bonds as the ballast in the portfolio, softening the impact of much more volatile equities.

Speaking of volatile, let’s look next at Emerging Markets.  In 2017, Emerging Markets outperformed all asset/subasset classes. However, this same category now trails all others in 2018.  International Developed Markets tell a similar tale, with the MSCI EAFE Index outperforming the S&P 500 in 2017, but down slightly 2018.

Further, the divergence between growth and value has seldom been larger.  The Russell 1000 Growth Index is outperforming its Value counterpart by over 10%.  This has led some to wonder why they are in all of these different investment categories. Why not just invest in Large Cap Growth and Tech and stay there? 

The answer is twofold: First, we never know exactly when an investment category will come in or out of favor. (Remember the late 90s with the tech bubble? Investors asked those same two questions).   Last year’s darling can easily become this year’s detractor, as seen recently in Emerging Markets.  By the time investors try to adjust tactically, the move may be over.  Indeed, chasing returns generally just leads to buying assets at high prices.

Second, a portfolio can’t win with just one or two superstars.  Think of LeBron James. Arguably one of the best basketball players of all time, his skill and scoring ability were not enough to win the title for Cleveland last year. Why?  Because it takes more than one or two stars playing for the entire game (or series) to bring home a championship.  Who knows when US stocks might get ‘injured’, or when bonds might have a chance for some ‘free throws.’   The best likelihood for success comes from having a whole team of great players, knowing that some will be ‘hot’ when others are having a tough game.

Rest assured, the team at HFA is absolutely committed to building world class portfolios.  Our fund due diligence ensures only the best in breed funds get selected for our portfolios, with institutional share classes allowing the lowest costs. We are absolutely convinced that the optimal way to capture returns in the best performers, is to invest in a diversified portfolio, and then stay invested.  If you have questions regarding your investment portfolio, contact our office; we are always available to help.


[i] “Determinants of Portfolio Performance”, Brinson et al., Financial Analysts Journal, 1986