Markets were lower yesterday across the board, but the feeling in the air, so to speak, was more calm, as evidenced by the four percent drop in the CBOE Volatility index. Granted, it was a four percent drop following a 40 percent increase last week, but the direction was right.
Bonds fell, as measured by the 10-year US Treasury bond, as bond investors pulled away from the ‘flight-to-quality’ trade and considered the impact of a possible announcement from the Federal Reserve on Wednesday.
Yesterday, I had the pleasure of attending an investment committee meeting for one of our institutional accounts. I actually don’t work directly with the client and was asked to come by one of our Portfolio Managers, Joe Kelley.
The client has a pretty conservative portfolio with far more bonds than stocks. As we discussed the portfolio, one of the board members asked if they were ‘too conservative,’ should the have more stocks and what other institutional accounts were doing.
I naturally went to my stock answer, which is, ‘it depends on client circumstances.’
My answer seemed unsatisfying to the group, so I went on to say that it was more conservative than other institutional accounts that I work with and that I thought that stocks offered more attractive returns than bonds over the long run.
I was a little worried that the question was the result of looking at reports from 2013 that showed wonderful returns for stocks and lousy returns for bonds.
But before I could say as much, one of the other committee members chimed in and said, ‘Guy’s if you think back to three years ago when we opened this account, we said that our goal was to simply get our money back with a small return – we wanted a vey high probability of a positive return and we gave a specific three-year time horizon.
Well, if you have a three-year time horizon and your goal is to not lose money, then the allocation is right on the money!
The bonds have earned low but stable returns in the first two years and last year, when bonds lost, diversification worked perfectly and the stocks more than offset the losses.
It’s true that there was a chance of loss in the whole portfolio if we’d experienced another crash like we had in 2008, but the odds of that are pretty low – less than one percent.
The moral of the story is that my first, canned answer was the right one even though it wasn’t the most satisfying initially.
As much fun as it is to talk about stocks, bonds, valuation, Fed policy and all the rest, client goals trump everything else.