Stocks surged in 2021, continuing their torrid recovery from the pandemic-fueled sell-off in February and March 2020. Since bottoming out at 18,591 on March 23rd, 2020, the Dow Jones Industrial Average has gained a whopping 97%. And that’s actually on the low end of the major market indices, as seen in the chart below:
These gains came against a backdrop that could hardly be described as “cheery.” COVID mutations, supply-chain disruptions, and rising inflation have dominated the news cycle since the 2020 economic shut down. Yet stocks, as they often do, climbed the wall of worry. The powerful recovery in equities these past 22 months underscores one of the central pillars of our investment philosophy: Dramatic gains often come when we least expect it, and the only way to be sure we reap the rewards is to be fully invested at all times.
Yet, today, the talking heads in the financial media are warning us about stocks being “overbought,” “due for a downturn,” and other ominous phrases that all point to the same underlying theme:
Run! Get Out! Protect yourself and your money before it’s too late!
The whole point of creating an investment policy statement and building an efficiently diversified portfolio is to seek the balance between the return you need and the volatility you can handle. When we focus on process, not current events or subjective guesses about whether stocks are too high, we greatly increase the odds of attaining your long-term investment goals.
As we have noted many times, individual investors have a long, depressing history of chasing performance. The hot stock or fund du jour is a temptation too great for many investors to resist. Alas, most invariably arrive too late to the party and are left holding the bag.
A recent and relevant example of this is the ARK Innovation Fund (ARKK), an exchange-traded fund (ETF) that invests heavily in large tech and cryptocurrency companies. ARKK went on an absolute tear from February 2018 through February 2021, posting a total return of more than 290% –more than five times
the S&P 500’s return for the same time period.
Over the long term, about 90% of active managers under perform their market benchmarks, and even the slim minority who do beat the market usually do so by only a percentage point or two. So, when a fund outperforms the broad market by a multiple of 5X, suffice to say it's due for a return to reality. This is known as reversion to the mean
– the statistical reality that outliers don't remain outliers forever, or even for long.
Logic would dictate the recent high flyers are the very ones to most avoid. Yet, predictably, investors flocked to ARKK in 2020 and early 2021. From a relatively meager asset base of $116 million in 2017, the ARK Innovation fund’s assets-under-management exploded to $25.5 billion (with a “b”) by 2021. Nearly all the inflows came after the fund had already posted most of its staggering returns.
You already know how this story ends, but we'll tell you anyway. Since last June, ARKK has lost more than 40%, even as the S&P 500 gained 11.50%. In a well-researched analysis on Morningstar.com
, Amy Arnott lifted the hood on ARKK and found that the average investor’s return in the fund was a mere fraction of the fund’s stated return: