A Word From The Advisor

Sometimes human nature takes over. For some of us, when the stock market reflects signs of a stabilizing economic recovery, we cast aside long-term asset allocation plans that were originally established to meet our investment objectives.

In the current market environment, some investors are reducing the percentage of fixed income in their portfolio, selling out of bonds and buying stocks for fear of missing out on higher returns. This trend is somewhat analogous to what we saw in the 1999-2000 period, when investors were shifting their portfolios away from bonds into a maximum stock exposure in order to ride the tech wave. When the wave crashed, wipeout ensued.

Some investors are savvy, or lucky, enough to profitably time the markets — but they are the exception. Millions of investors chase returns after hearing about market ups and downs from their co-workers or on the nightly news. A recent study shows that most equity investors who try to time the market earn less than inflation as they fruitlessly try to buy low and sell high.

History has shown that investors are not swayed by major political events. Trading volume remained flat for equity and fixed income mutual funds through major political events including the US Cole bombing in October 2000, the Bush/Cheney Election in November 2000, and the World Trade Center attacks. Instead, it is the volatility in the market that drives investors to trade. Monthly cash flows in and out of equity and fixed income mutual funds track almost exactly to the market – and have done so since 1984. Trading volume spikes along with spikes in the market.

The adherence to a personal investment policy is difficult at times and requires discipline. However, holding fast to a planned asset allocation through a market cycle has been proven to be the most important decision that you as an investor can make in determining whether or not over time you will earn the rate of return needed to meet investment goals. The continuous chase to capture investment returns has investors pouring money into the equity market on upswings and quickly selling on the downturns, attempting to time the market. This strategy, with few exceptions, is an exercise in futility.

To illustrate, over the past twenty years, the total annualized return of an investor who invested in the market on the best day each year, that is, the year’s low, was 11.7% (as measured by the unmanaged Dow Jones Industrial Average). This is an impressive return, and is cause for envy among those of us who have never invested on the best day in one year, much less for the past twenty. That is, until you compare this return to an investor who invested on the worst day each year, that is, the year’s high, and find that this investor has earned an annualized rate of return of 10.2% — still impressive. Someone who timed it right every year had at best marginal incremental return over someone who invested at exactly the wrong time. Even this extreme illustration shows there is little to be gained from trying to time when to enter and exit the stock market.

The risk of a portfolio, defined in terms of volatility, will be largely driven by the asset allocation decision as well. The power of diversifying your portfolio across asset classes comes from reducing risk as much as it does from increasing returns. With a factor of 1.0 meaning that the two markets move in lockstep, and a factor of 0.0 meaning that there is no relation at all, the correlation between the broad US equity market, represented by the Russell 3000 Index, and the broad US bond market, represented by the Lehman Brothers Aggregate Bond Index, is 0.4 (measuring monthly returns from January, 1988 through December, 2000). This low correlation figure provides persuasive support for adhering to a long-term stock and bond mix to reduce risk as well as to reach investment goals.

Oakwood’s investment philosophy for both fixed income and equity securities encompasses the following basic tenets:

• Both fundamental and quantitative disciplines are employed to identify attractive securities;

• Diversification is used to control risk; and

• Sell disciplines are an integral part of the investment process.

We are proactive in the management of bonds and stocks in order to seek and recognize opportunities and evaluate uncertainties.

• Oakwood’s active bond management approach is designed to produce excellent relative performance in all interest rate environments. We are poised to respond to market events and add value through our proven management process. We also take into consideration present and future economic factors to determine where we will find yield advantage, and perform extensive stress testing to negative events to identify areas of weakness in order to protect and strengthen our clients’ portfolios.
  

• Oakwood’s equity management approach utilizes the analytic disciplines of top-down fundamental analysis, proprietary quantitative modeling, and bottom-up fundamental analysis to identify potential candidates. We have an ongoing process whereby each stock is continuously reviewed for its value and its appropriateness for client portfolios. Our comprehensive sell discipline will identify when a stock has attained its full value, has deteriorating fundamentals, is consistently underperforming, or has unexplained downside volatility. At this point, the security becomes a sell candidate.

Market uncertainty, pendulum-like price swings, and conflicting commentary that has nothing to do with fundamentals have given investors unnecessary cause to shift in and out of primary asset classes. It is important to avoid aggressive return expectations and rely on our professional investment advice, rather than “market noise” and emotion. As always, we continue to be proactive with asset allocation decisions, and to manage investments in the best interest of each Oakwood client.