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Have you ever been asked about your investing risk preference? Or have you been investing based upon gut instincts, hunches or emotions? Maybe you’ve discussed risk in a subjective way based upon your age. What if I asked you:

“How far can your portfolio fall, within a certain period of time, before you make a poor investing decision?”

4 out of 5 people have more risk in their portfolios than they realize. But it can be as simple as 5 minutes to determine an acceptable amount of risk your family is willing to take, for an acceptable return.

Park + Elm Investment Advisers has invested in award winning technology from our partners at Riskalyze, that defines an individual’s risk tolerance through the patented “RISK NUMBER”. We invite you to take 5 minutes to identify YOUR risk number. It’s simple, quick, free and crucial to your investment experience.

My risk number is a 67! Click on the button above to find out yours!

Trivia time: how many stocks make up the Wilshire 5000 Total Market Index (a widely used benchmark for the US equity market)?

While the logical guess might be 5,000, as of December 31, 2016, the index actually contained around 3,600 names. In fact, the last time this index contained 5,000 or more companies was at the end of 2005. This mirrors the overall trend in the US stock market. In the past two decades there has been a decline in the number of US-listed, publicly traded companies. Should investors in public markets be worried about this change? Does this mean there is a material risk of being unable to achieve an adequate level of diversification for stock investors? We believe the answer to both is no. When viewed through a global lens, a different story begins to emerge—one with important implications for how to structure a well-diversified investment portfolio.

U.S. Against the world

When looked at globally, the number of publicly listed companies has not declined. In fact, the number of firms listed on US, non-US developed, and emerging markets exchanges has increased from about 23,000 in 1995 to 33,000 at the end of 2016. (See Exhibit 1.)

It should be noted, however, that this number is substantially larger than what many investors consider to be an investable universe of stocks. For example, one well-known global benchmark, the MSCI All Country World Index Investable Market Index (MSCI ACWI IMI) contains between 8,000 and 9,000 stocks. This index applies restrictions for inclusion such as minimum market capitalization, volume, and price. For comparison, the Dimensional investable universe, at around 13,000 stocks, is broader than the MSCI ACWI IMI.

Exhibit 1. Number of Publicly Listed Companies

Source: Bloomberg

While it is true that in the US there are fewer publicly listed firms today than there were in the mid-1990s (a decrease of about 2,500), it is clear that the increase in listings both in developed markets outside the US and in emerging markets has more than offset the decline in US listings. Although there is no consensus about why US listings have decreased over this period of time, a number of academic studies have explored possible reasons for this change. One line of investigation considered if changes in the regulatory environment for listed companies in the US relative to other countries may explain why there are fewer listed firms. Another considered if, since the 2000s, private companies have had a greater propensity to sell themselves to larger companies rather than list themselves. In either case, the implication for investors based on the numbers alone is clear—the number of publicly listed companies around the world has increased, not decreased.

a global approach

In the US, with thousands of stocks available for investment today, it is unlikely that this change will meaningfully impact an investor’s ability to efficiently pursue equity market returns in broadly diversified portfolios. It is also important to note that a significant fraction of the publicly available global market cap remains listed on US exchanges. As noted in Exhibit 2, the weight of the US in the global market is approximately 50–55%. For comparison, it was approximately 40% in 1995.

For investors looking to build diversified portfolios, the implications of the trend in listings are also clear. The global equity market is large and represents a world of investment opportunities, nearly half of which are outside of the US. While diversifying globally implies an investor’s portfolio is unlikely to be the best performing relative to any one domestic stock market, it also means it is unlikely to be the worst performing. Diversification provides the means to achieve a more consistent outcome and can help reduce the risks associated with overconcentration in any one country. By having a truly global investment approach, investors have the opportunity to capture returns wherever they occur.

Exhibit 2. Percent of World Market Capitalizations as of December 31, 2016

Data provided by Bloomberg. Market ap data is free-­ oat adjusted and meets minimum liquidity and listing requirements. Many nations not displayed. Totals may not equal 100% due to rounding. China market capitalization excludes A-shares, which are generally only available to mainland China investors.

CONCLUSION

While there has been a decline in the number of US-listed, publicly traded companies, this decline has been more than offset by an increase in listings in non-US markets. While the reasons behind this trend are not clear, the implications for investors today are clearer—to build a well-diversified portfolio, an investor has to look beyond any single country’s stock market and take a global approach.

Source: Dimensional Fund Advisors LP.

Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Diversification does not eliminate the risk of market loss. Investing risks include loss of principal and fluctuating value. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

Indices, such as the MSCI All Country World Index Investable Market Index (MSCI ACWI IMI) are not available for direct investment.

Many people struggle to separate their emotions from investing. The chart above shows the correlation between emotional cycles and market returns. Investors typically buy at “Elation” and sell at “Fear”, inherently creating a dreaded “selling low, buying high” strategy.

A philosopher once said that nothing is as difficult for people as not deceiving themselves. But while most self-delusions are relatively costless, those relating to investment can come with a hefty price tag.

Market volatility in 2008 and 2009 took investors on a bumpy, emotional ride. Despite the market’s strong performance after March of 2009, many investors were too exhausted to endure the ongoing stress of an uncertain economy and market. By making an emotional decision to avoid the stress, there are millions of investors who never recovered their losses and sacrificed the enormous gains that would follow.

On the contrary – prior to the tech bubble of the early 2000’s, investors were pumping money into the dot coms because they saw their neighbor or co-worker getting rich. Driven by media and emotional investing, American’s poured their savings into tech stocks, only to endure the bubble bursting in 2000.

Some media outlets claim a similar bubble for tech stocks in ‘15 and ‘16. A Bing search on this claim literally pulled up the following article titles, one after another on page 1:

“Why this Tech Bubble is Worse than the Tech Bubble of 2000”

“Why this Tech Bubble is Less Scary than the Tech Bubble of 2000”

Magazines sell by appealing to the emotions of a reader. When it comes to investments, reacting to what you read or see on TV can be detrimental to your long-term retirement plan. Keep these tips in mind before making an emotional investment decision:

1. Market timing is hard.
2. Never forget the power of diversification.
3. Markets and economies are different things.
4. Discipline is rewarded.

Overcoming self-deception is not impossible. It just starts with recognizing that, as humans, we are not wired for disciplined investing. We will always find one way or another of rationalizing an emotional reaction to market events. But that’s why even experienced investors engage advisors who know them, and who understand their circumstances, risk appetites, and long-term goals. The role of your advisor is to listen to and acknowledge your very human fears, while keeping us in the plans we committed to at our most lucid and logical moments. Can you say with confidence that your investment decisions are based on a long-term strategy, or are your current emotions playing a role?

A Core principle of the Park + Elm’s Investment Strategy is investing efficiently, and adding value by analyzing and reducing portfolio expenses. We focus on partnering with firms that value those same principles, in order to deliver a cost efficient, research based portfolio for our clients.

It’s been a great 2017, and we are thankful to be partners with two respected organizations that announced fee reductions in January. As a fiduciary, we continuously analyze the cost of building a portfolio, and work with these partners to add value through reducing expenses. Charles Schwab and Dimensional Fund Advisors have both announced cost cutting adjustments for 2017.

Charles Schwab, Inc.
Charles Schwab, the brokerage firm that custodies our firm’s assets, has significantly cut expenses on several of its open-ended index funds, announcing a reduction to the same level as their equivalent ETF’s. We currently use both Schwab open-ended index funds, as well as the equivalent ETF’s, so this directly affects the value of our portfolios.

Additionally and most importantly, the lowest expense ratio would apply to all investors, whether they invested $1 or $1 million. In normal industry practice, institutions with $1 million or more to spend get significantly lower expense ratios than individuals with $500 to invest. Schwab’s lower expenses will start March 1.

Schwab will also reduce standard online equity and ETF trade commissions from $8.95 to $6.95, which, Schwab says, is lower than those charged by Fidelity, TD Ameritrade, E*Trade and Vanguard. The lower commission rates start Friday, Feb. 3.

Dimensional Fund Advisors
Dimensional Funds also announced a reduction in expense caps and investment management fees for 2017 relating to 10 of their mutual funds. Dimensional Funds are the building blocks of our portfolios, and have been a preferred partner of Park + Elm for 16 years. Dimensional’s foundation is based upon investing practically and EFFICIENTLY, and they continuously evaluate investment management fees and overall expenses. Dimensional Funds have had a long history of low-expenses and turnover in their funds, which is a core reason for our long-term partnership. As of January 1, 2017, expense cap reductions were already effective, and management fee reductions will be effective February 28, 2017.

This is a BIG deal. This will positively affect our portfolio values, and, long-term, can make an impactful difference in retirement. Investing in equity markets can be risky and volatile, but expenses are one controllable aspect of an investment strategy. These efforts also confirm that Park + Elm, Charles Schwab and DFA are working to give clients the best products, in the most efficient way.

This report features world capital market performance and a timeline of events for the past quarter and the past year. It begins with a global overview, then features the returns of stock and bond asset classes in the US and international markets.

The report also illustrates the impact of globally diversified portfolios and features a quarterly topic.

CLICK HERE!

QUARTERLY AND ANNUAL MARKET REVIEW

It’s not enough to diversify by security. Deeper diversification involves geographic and asset class diversity. Holding a global portfolio helps to lower concentration in individual securities and increase diversification.

Over long periods of time, investors can benefit from consistent exposure in their portfolios to both US and non-US equities. While both asset classes offer the potential to earn positive expected returns in the long term, they may perform quite differently over shorter cycles. The performance of different countries and asset classes will vary over time, and there is no reliable evidence that performance can be predicted in advance. An approach to equity investing that uses the global opportunity set available to investors can provide both diversification benefits as well as potentially higher expected returns.

The global equity market is large and represents a world of investment opportunities. Nearly half of the investment opportunities in global equity markets lie outside the United States. Non US stocks including developed and emerging markets, account for 47% of world market cap and represent more than 10,000 companies in over 40 countries. A portfolio investing solely within the US would not be exposed to the performance of those markets.

However, when Americans talk about the stock market, they’re generally referring to the Standard & Poor’s 500 index or the Dow Jones industrial average. But these indices represent only one part of the available investing universe. The total U.S. stock market makes up only about 53% of global market capitalization. Yet, on average, U.S. mutual fund investors possess a home bias, with a disproportionate amount of their portfolio invested in the United States. If their portfolios were balanced according to world market capitalization, about half of their assets would reside in non-U.S. stocks. This “home bias” leads to less diversification, and as a result, greater volatility with lower returns.

It’s well know that concentrating in one stock exposes you to unnecessary risks, and diversifying can reduce the impact of any one company’s performance on your wealth. From year to year, you never know which markets will outperform, and attempting to identify future winners is a guessing game. Diversification improves the odds of holding the best performers, and by holding a globally diversified portfolio, investors are positioned to capture returns wherever they occur.

Put very simply, DIVERSIFICATION:

·         Helps you capture what global markets offer

·         Reduces risks that have no expected return

·         May prevent you from missing opportunity

·         Smooths out some of the bumps

·         Helps take the guesswork out of investing

There is no single perfect portfolio. There are an infinite number of possibilities for allocation based on the needs and risk profile of each individual. The most important question investors should ask… “IS MY PORTFOLIO GLOBALLY DIVERSIFIED?”

Throughout history, many of the greatest advancements in finance have come from Academia. Our investment philosophy has been shaped by decades of research by leading academics. We structure portfolios on the principles that markets are efficient; that returns are determined by asset allocation decisions, and that portfolios can be structured around dimensions of expected returns identified through academic research. It is through our strategic partnership with Dimensional Fund Advisors, a leading global investment firm that has been translating academic research into practical investment solutions since 1981,  that we can pursue dimensions of higher expected returns through advanced portfolio design, management, and trading. 

Much of what we have learned about expected returns in the equity and fixed income markets can be summarized in these dimensions.

1. Stocks have higher expected returns than bonds – it has been well documented over time that stocks outperform bonds, and that risk = reward
2. Among stocks, expected return differences are largely driven by company size – small companies have higher expected returns than large companies.
3. Relative price – low relative price “value” companies have higher expected returns than high relative price “growth companies.
4. Profitability – companies with high profitability have higher expected returns than companies with low profitability.

Since 1981, Dimensional has incorporated rigorous academic research on the capital markets into the design, management, and trading of clients’ portfolios. Some of the major milestones in academic research shown in the chart below have had a profound effect on our investment philosophy.

Our enduring philosophy and deep working relationships with Dimensional and the academic community underpin our approach to investing. Over a long period of time, Academics have been able to identify dimensions of higher expected returns, and with Dimensional, we can structure portfolios around these dimensions in a very cost-effective manner.

Information provided by Dimensional Fund Advisors LP.

US size premium: Dimensional US Small Cap Index minus S&P 500 Index. US relative price premium: Fama/French US Value Index minus Fama/French US Growth Index. US profitability premium: Dimensional US High Profitability Index minus Dimensional US Low Profitability Index. Dev. ex US size premium: Dimensional Intl. Small Cap Index minus MSCI World ex USA Index (gross div.). Dev. ex US relative price premium: Fama/French International Value index minus Fama/French International Growth Index. Dev. ex US profitability premium: Dimensional International High Profitability Index minus Dimensional International Low Profitability Index. Emerging Markets size premium: Dimensional Emerging Markets Small Cap Index minus MSCI Emerging Markets Index (gross div.). Emerging Markets relative price premium: Fama/French Emerging Markets Value Index minus Fama/French Emerging Markets Growth Index. Emerging Markets profitability premium: Dimensional Emerging Markets High Profitability Index minus Dimensional Emerging Markets Low Profitability Index. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. See “Index Descriptions” for descriptions of Dimensional and Fama/French index data. Dimensional Fund Advisors LP. The S&P data is provided by Standard & Poor’s Index Services Group. MSCI data © MSCI 2016, all rights reserved.

Education planning is a complex issue. A disciplined approach to saving and investing can help remove some of the uncertainty from the planning process. With the increasing price tag of higher education, talking to your advisor about investment vehicles for college is crucial.

Check out this in depth look by Dimensional Fund Advisors at planning for higher education, and contact us if you want to know more about the significant benefits of funding a 529 before the December 31st deadline.

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