Investors must always look forward. They must look to the future because they have to try to make money in all kinds of markets — booms and busts, and all levels of uncertainty.
However, on the occasion of Pensions & Investments' 35th anniversary — with investor uncertainty now at a high, as measured by the volatility index, and with the stock market plunge devastating retirement assets and investment confidence — it is appropriate to reflect on the past to gain perspective on the current crisis and the future.
P&I was started in the depths of one of the worst markets in history, when analytical and informational tools were limited, when investment innovation was virtually non-existent, and much of the information now taken for granted was unavailable, if even collected.
P&I published its first issue in the early months of what turned out to be the 1973-'74 bear market, which produced a -20.8% annualized return, the worst since the Depression years of 1931-'32 with their 27.9% annualized loss.
Wall Street was then a powerful oligopoly and investors were compelled to trade securities under its fixed commission structure, although use of so-called off-Wall Street discount brokers was beginning.
The freeing of commissions in 1975 began a gradual reduction in trading costs for investors, and contributed to a surge in trading volume.
The seminal Ibbotson-Sinquefield study of stock, bonds, bills and inflation — which showed the returns for each asset class since 1926, provided empirical evidence for equities as the superior risk-adjusted asset class and became the foundation for asset allocation models — wasn't published until 1976.
Even the idea of measuring pension fund performance was disputed in 1973, although pioneering firms like A.G. Becker Inc. with its Funds Evaluation Group already were showing how to do it. Academic theories like beta, a measure of the sensitivity of a portfolio to the market, were only beginning to come into use.
The revolution in computer technology, especially the invention of the PC and Macintosh and their powerful analytical software, began to take hold only in the 1980s, transforming portfolio management. The Internet was unknown.
Financial derivatives virtually were unknown in 1973. Only options were in common use. The S&P 500 futures contract, the first major equity index derivative, began trading in 1982.
In 1973 investment management still was dominated by bank trust departments and insurance companies, while investment counselors, as they were called then, were only beginning to win pension fund clients.
U.S. pension assets in 1973 totaled $283 billion. Last year, the top 1,000 defined benefit assets totaled $5.4 trillion.
These changes and many others just as important — such as short selling, alternatives strategies, hedge funds, international diversification, etc. — have changed the ways in which institutional investors seek to make the assets under their control grow.
Most large pension funds, endowments and foundations have sought to use the latest tools to mitigate the effects of market downturns. But institutional investors should now have learned they cannot completely insulate their assets from bear markets with even the most sophisticated programs.
The best they can do is use the available tools to minimize the losses, and be prepared to take advantage of the economic and financial market recoveries when they come. They must rigorously analyze what strategies worked and why they worked, and which strategies failed, and why they failed. They must accept that while the market rises most of the time, for significant periods it can decline.
Institutional investors today have a plethora of powerful tools to manage investments and risk, making them better equipped to do so than they were 35 years ago. But the market has kept up too, and usually is one step ahead — as it was in the current market debacle.
The history of the past 35 years shows that as the financial markets evolve, institutional investors must evolve. But investors can never assume they have unlocked the secrets of high risk-adjusted returns in perpetuity.
The market will always have new lessons to teach those who become overconfident.
