Expect the Unexpected

07/21/2011 12:30 pm EST


Paul Justice

Associate Director of North American ETF Research, Morningstar, Inc.

The market is always full of surprises, so it’s best to be prepared for them, writes Paul Justice of Morningstar ETFInvestor.

Without fail, two interesting things happen in Chicago each June. First, the weather abruptly shifts from about 55 degrees one day to 95 the next, which brings with it more than just sweaty discomfort—my house was actually hit by a small tornado this month!

Luckily, we suffered only minor cosmetic damage, but it still reminds me to expect the unexpected. Certainly, that is a lesson we know all too well, given the market spasms of the past few years.

And to say I expected a smoother market ride is an understatement.

Where We’ve Been
It is never our goal to shoot for the moon on the returns side if it puts our capital at undue risk. I hope that was telegraphed with our first portfolio moves of selling ETFs in the homebuilding and financials sectors, well before Lehman Brothers was thrown to the sharks.

That move actually made a headline in The Wall Street Journal, which made us realize we were doing something a tad controversial at the time (perhaps too risk-averse).

If that move was vexing to you at the time, I hope it began to make sense as we amassed a cash pile of 60% of our portfolio before the perilous depths of the crisis were realized. In that regard, it was the purchases we never made that helped us the most.

And, believe me, there is a lot of pressure to keep surfacing ideas in this business. Nothing reveals a cautious stance more than the idle hands of a money manager near a pile of cash.

Moving Forward
From a strategic viewpoint, having cash laying around is no longer our concern. We are nearly fully invested, and we have several ideas we’ll be executing in the next few months.

Coincidentally, some of those ideas are similar to those shared at the second interesting thing that happens in Chicago every June: the annual Morningstar Investment Conference. Every summer, several of the top money managers in the world make the pilgrimage to the Windy City to share what’s on their minds (and to drum up interest in their wares).

One virtually universal theme among the diverse set of managers is that large-cap equities in developed markets are undervalued today, which is a point we’ve made several times in the past year.

Not once did I hear someone say that they are scared off by these valuations, or that investors should be heavy in fixed income. Larry Fink, CEO of the world’s largest money manager, BlackRock, went as far as to say that he’d be 100% invested in equities if his accountants would let him.

I certainly wouldn’t go that far—and I suspect he’s exaggerating a bit to make his point—but I have to agree that the perceived safety of bonds could be a myth once rates start rising.

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