Beware The Trappings Of Success

By Gregory S. Davis | March 25, 2009 AAA

The problem with being the best performing asset class in any given year is having the challenge to stay there for an extended period of time. Asset classes ranging from international investments in Europe, Asia and the Far East to large-cap growth and most recently fixed-income investments have all been the best places for investors to put their money for the last five years. Let's take a look at why no one asset class has managed to stay at the top of the heap and what it means for investors.

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Change

According to BlackRock's "Asset Class Returns: 20-Year Snapshot" ending in 2008, the fixed-income asset class outperformed other former top-shelf asset classes from the two prior years including large-cap growth in 2007 and internationals in 2006. While fixed-income investments finished in positive territory for the year large-cap growth and international investments finished at the back of the pack for asset class superiority.

Asset Class ETF Proxy
International iShares Morgan Stanley Capital International EAFE Index
(NYSE:EFA)
Large-Cap Growth iShares Russell 1000 Growth
(NYSE:IWF)
Fixed Income iShares Barclays Aggregate Bond
(NYSE:AGG)
Large-Cap Value iShares Russell 1000 Value
(NYSE:IWD)
Small Cap iShares Russell 2000
(NYSE:IWM)


Reasoning
Investors can take their pick of reasons from the war in Iraq to subprime mortgages to tight credit markets for the slowdown in the global economy. The last time fixed income led the pack was between 2000 and 2002 - just as the technology bubble was losing steam. Prior to those dates fixed income has not been a leader among its asset class cohorts since 1990, when another global economic recession was gaining strength. During the early '90s, the economic environment in the U.S. was characterized by a sluggish economy, the beginning of the Gulf War, high oil prices and high unemployment. By looking back at history investors can notice how economic headlines from the early '90s are similar in many ways with those of 2008 and 2009.

The Way Forward
Two asset classes that have not grabbed the top spot with the past five years include small-cap stocks and large-cap value stocks. While there is no guarantee that small-cap or large-cap value stocks will rise to the summit above the other asset classes in the near future, it may be wise to consider the cyclical nature of the market and how most asset classes that do reach the top have tended to fall to the bottom of the pile in the following two- or three-year period.

Final Thoughts
Our emotional side draws us to asset classes with the best performance in recent history. The downside of this emotional response is the definition of chasing returns. Discipline will allow investors to embrace the cyclical nature of the market, and rather than banking on the current "King of the Hill", investors are better off building a diversified portfolio.

Be sure to read Diversification: It's All About (Asset) Class to see how asset class selection is simpler and safer than stock picking.

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