Review: Abnormal Returns

October 25, 2012

Tadas Viskanta’s blog, Abnormal Returns, has gained a large and prestigious following during its seven-plus years. His new book of the same name also deserves a wide readership. Abnormal Returns (McGraw Hill, 2012) is not so much an argument for a specific strategy as a catalogue of wisdom. “This book should be read more as an exploration of a series of investment topics as opposed to some sort of doctrinaire investment philosophy,” Viskanta writes.

In his chapter on equity investing, he discusses the surprising relationship between the stock market and the economy. From listening to the news, it’s easy to infer that a weak economy produces poor market returns, but the last three years have shown it’s not that simple. The US, he writes, “continues to operate with generally tepid economic growth, headline unemployment rates well in excess of 9%, and a budget deficit well in excess of a trillion dollars,” yet the S&P 500 has more than doubled since 2009. The lesson is that weak economies are a bit like value stocks, while the burgeoning emerging markets are closer to growth stocks. For the patient investor, it is value that outperforms.

Think global

Viskanta’s chapter on global investing includes a compelling case for international diversification. He points out that investing outside one’s own country is a long-term hedge: “We aren’t talking about the zigs and zags of the current global economy. Rather we are talking about the big, secular shifts that occur over decades.” Citing this paper, he argues global investing has very little short-term benefit, and indeed, during market turmoil correlations are so high that international exposure offers little protection. However, “the risk for investors is that they are concentrated in a country that has exhibited, or is going to exhibit, relatively poor economic performance over a long period of time.” He’s appealing to US investors, many of whom assume their country’s economic superiority will last indefinitely, but the Japanese would back him up. And let’s face it—many Canadian investors are similarly smug and should also heed this warning.

Help not wanted

In his discussion of behaviors and biases, Viskanta points out a little-discussed downside to financial literacy education. Here he quotes the controversial scholar Lauren E. Willis, who writes: “In reality, this education may do no more than increase overoptimism and the illusion of being able to control financial risks.” Indeed, when it comes to assessing our own investing knowledge, most of us are overconfident and reluctant to seek help. Part of the reason, of course, is that the financial industry is swarming with sharks. But I was surprised to read about a study that found the vast majority of investors declined investment advice even when it was free and unbiased, and most of those who did accept the offer ignored the advice. “No matter the circumstances,” Viskanta writes, “we all need some strategy or structure to help buffer our portfolios from our worst instincts.”

If there’s an overriding theme in the book it’s that most investors should strive for simplicity: “Some will argue that a regularly rebalanced, well-diversified portfolio managed with risk, low costs, and taxes in mind is a suboptimal strategy,” he says in the book’s conclusion. “They will point to research showing a particular strategy that outperforms what amounts to a simple, boring portfolio. They will be right in the strictest sense. The greatest challenge for investors isn’t putting together a strategy; it is putting together a strategy that they can follow over time.”

{ 9 comments… read them below or add one }

Jon Evan October 25, 2012 at 1:07 pm

I agree: “The greatest challenge for investors isn’t putting together a strategy; it is putting together a strategy that they can follow over time.” Viskanta tells us why this is so challenging: “we all need some strategy or structure to help buffer our portfolios from our worst instincts.”
In medicine, it is true that the doctor who treats himself has a fool for a patient. The reason is obvious. It is impossible to be objective particularly with medicine which is not a pure science. Is investing not likewise? The issue of our own “worst instincts” prevents us in the long term from remaining objective with our own portfolio management and maybe it’s true for some of us that the DYI has a fool for a client! Using a fee only financial advisor is very worthwhile I think for most of us who suffer from “worst instincts” syndrome!

James Allen October 25, 2012 at 3:42 pm

Hmmm, doesn’t really make me want to rush out and buy this!

Peter October 25, 2012 at 10:52 pm

I like the theme of global diversification reiterated here. It is important to not just focus on Canada. And for many investors, the focus is just on Canada, and some on just Canada and US. I think looking beyond at least our own home nation, and also outside of North America, will be important in the long run. Right Dan?
I think John Degoey of BNN often emphasizes this point as well. He is the only guy on BNN that I actually listen to.

Canadian Couch Potato October 26, 2012 at 8:28 am

@Jon: Thanks for the perspective. I do know several financial professionals who use an adviser, not because they need someone with more knowledge, but because they need someone to be help them control their impulsive behaviour.

@James: I’m curious: What did I say to turn you off?

@Peter: Over the very long term (and investors aren’t very good at thinking longer than two or three years) it doesn’t make a lot of sense to assume that your home country will be the best place to invest. Canada has a very small, very poorly diversified stock market that will certainly enjoy periods where it underperforms the rest of the world. And as Viskanta points out, sometimes those periods can be very long.

Ryan October 26, 2012 at 1:59 pm

In his book, he has a chapter called “Alternative Assets”. Can someone please tell me what this includes? I don’t want to buy the book to find out.

Canadian Couch Potato October 26, 2012 at 2:06 pm

@Ryan: That chapter discusses hedge funds, private equity/venture capital, options, managed futures, REITs and gold. His conclusion is that individual investors should generally avoid all of these except REITs (and perhaps managed futures for their diversification benefit).

Ryan October 26, 2012 at 3:20 pm

What’s the knock on options?

Andrew October 27, 2012 at 3:47 pm

I think a key problem with a lack of financial literacy is how it is used as a lever to charge high fees in the financial services industry. Mutual fund fees in Canada are still way too high and even 1.5% or 1% for an ETF only portfolio, which seems to be the going rate, may eat up half the real return if we are in a low return world for a while or if you are retired and have over half your portfolio in bonds and bond funds.

Its even worse if the advisor doesn’t have a fiduciary requirement.

I get how one can become ones own worst enemy, especially with volatility but I am sure there is an alternative model out there, based on a platform that exploits information technology that can offer low cost fiduciary advice and management of an all ETF portfolio. I am fiddling around with the math on this one myself right now.

Related: if you haven’t used up your 10 free articles yet, or have a subscription, search for the article “Regulators mull fiduciary duty for investment advisors” on The Globe and Mail site.

James Allen October 29, 2012 at 3:19 pm

Dan, nothing specific in your review, but regular readers of your blog have already digested most of these thoughts.

Leave a Comment

{ 3 trackbacks }

Previous post:

Next post: