Opinion

James Saft

Zen and the hell of low returns

November 13, 2013

Nov 13 (Reuters) – You can’t beat the market but the market
is probably going to slap you around a bit.

That’s the upshot from hedge fund guru Ray Dalio, who thinks
investing alpha, or outperformance, will be in short supply in
coming years. What’s worse, he sees equity returns, sapped by
years of QE, as only averaging about 4 percent a year for a
decade, with no diminution in volatility.

It’s enough to turn an investor to another of Dalio’s
interests: meditation.

Dalio, the founder of $120 billion hedge fund firm
Bridgewater Associates, thinks the Fed is getting diminishing
returns from its bond buying.

“It is working with a consistently decreasing effect and
will work with even less effect,” he told a conference sponsored
by The New York Times. (here)

“The Fed is trapped … and will not be able to raise
interest rates for a number of years.”

With asset prices already high, future returns will be lower
and the benefit to the economy less and less. That may force the
Fed to keep stimulating, but to less and less effect.

Perhaps the scariest part of this forecast is the idea that,
while returns will be relatively low, equity risk, or
volatility, will not go down. An asset class which remains
highly volatile, like equities, but returns only 4 percent a
year for a decade is a huge problem for investors.

Not only do they risk finding themselves short in a market
downdraft, investors will be, inevitably, tempted to bail out.

That classic small investor move then opens you up to
missing the rebound.

Dalio’s advice: spread your bets and don’t try to beat the
market.

“Most investors are not going to be able to produce alpha -
alpha is a zero sum. Most investors should create a balanced
portfolio against that,” he said.

Dalio is probably right, but that doesn’t make the situation
any better. Chasing outperformance is usually a losing game.
However a market returning 8 to 10 percent a year is much more
forgiving. If an investor spends 2.5 to 3 percent in fees making
10 percent, she’s still likely beat inflation by a fair amount.
Pay out 2 percent of 4 four percent, or even 1 percent of 4
percent, and things look a lot more grim.

LIVING IN A LOW RETURN WORLD

While creating a properly balanced portfolio is probably
your best bet, the payoffs are not going to be high. And if that
4 percent a year return prediction comes true, you are also,
almost certainly, going to have to rethink a lot of your
assumptions.

Let’s say you, like a lot of pension funds, assume you can
make 8 percent a year on a blended portfolio. Well you are only
getting about 2 percent on bonds, so if you have a 60/40
equities-bond split you are going to come up massively short if
your equities only return 4 percent. You need a 12 percent
return to make your target. And don’t expect bonds to outperform
- unless rates go massively negative there simply isn’t room.

So let’s pretend we are five years into the low-return
decade and you stop to take stock of your retirement plans. If
you have only made 2.5 percent a year for five years, the math
is going to show you are way behind your target asset
accumulation for retirement.

At that point you have essentially two options – neither
pleasant and both with consequences.

Many will react by taking on more risk. They will cling to
their high-return expectations and look for a charlatan who
promises to spin gold from straw. Some will get lucky, make
their target and think they are smart. Many more will squander
more on fees and see lower returns. A few will meet with fraud.

More sensible people will simply save more, or lower their
expectations for retirement. That’s a smart move, but one with
unpleasant side effects. If many people all start saving more at
once, economic growth will slow. The Fed, with all of its
bullets already shot, will face another slowdown with no ammo.

Now central bankers are creative and resourceful, and so we
might see some new tactic emerge to stimulate the economy. Then
again, we might not.

That brings us back to mediation, which Dalio credits for
much of his success.

So, close your eyes, empty your mind and breath deeply.

For 10 years or so, that may be all you’ve got.
(At the time of publication, Reuters columnist James Saft did
not own any direct investments in securities mentioned in this
article. He may be an owner indirectly as an investor in a fund.
For previous columns by James Saft, click on )

(Editing by James Dalgleish)

Comments
2 comments so far | RSS Comments RSS

As time goes on, I wonder if the current growth model taught to me as I earned my degree in economics is valid at all. Think about it. Physicists change their models of how the universe works when they discover that an old model no longer fits new data or information. The same goes for doctors. That food pyramid….gospel a few decades ago, today proven false. So far anyway. Tomorrow new discoveries may require more adjustments to theories in many branches of science.

Not so much in economics. As a species we seem wed to the ideas of Mr. Keynes and Mr. Hayack. I wonder where we would be today if scientists and engineers insisted on sticking with the laws of Sir Issac Newton. Sure Newton was a genius in his day and provided a foundation on which later scientists built, but key aspects of newtons famous laws of motion while correct in everyday circumstances have been shown to be incorrect or inexact in extreme situations such as at the microscopic level or near the speed of light. Newton simply didn’t have the information that we have today.

The world has changed dramatically in the past 100 years. Here we are though, promoting the same old processes. Fractional reserve banking is religion to many economists and most in power today. As I study the past 30 years it seems more and more obvious that economic theories based on infinite growth are as incorrect (or inexact) as some of Newtons ideas.

We need some new thinking. New theories based not on growth but on sustainability.

As far as your column is concerned, James I’ve made the decision a couple of years ago not to engage in investing at all anymore. No stocks, no bonds.

My returns are low. I still have plenty of assets though and have adjusted my spending down accordingly. Everyone seems to think that these adjustments are “bad”. It’s a funny thing though, I sleep better and enjoy life more……with less.

Perhaps the stock market here in America really is the “only game in town”. Even if it’s true, I don’t have to play.

Posted by Missinginaction | Report as abusive
 

Opps, I misspelled Hayek. That’s disrespectful.

Posted by Missinginaction | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •