INDEPENDENT INSIGHTS Market insights from an independent perspective

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April 16, 2019

Kevin Karpuk CFA

“I could tell it was going to be a terrible, horrible, no good, very bad day.” - Judith Viorst
Have you ever had a very bad day? If so, it is not a stretch to assume that the week in which that day happened was not a banner one, but the same is not necessarily true about the year or decade in which it occurred. Why is that? Well, the bad day was one-seventh of the week in which it occurred but only one-three hundred and sixty fifth of the year in which it happened. Over short time periods, statistics can be misleading, especially when one event impacts those surrounding it. But given enough time, even a horrible day fades into the background.



Just like a person, money managers go through tough times. Every manager that we employ on behalf of our clients will underperform a benchmark over some period for a myriad of reasons beyond the scope of this article. The chart above depicts how a quarter of underperformance affects longer periods of time. As you expand your time horizon, one bad quarter becomes not much more than a blip, but in the near term, a dismal quarter can ruin a manager’s year. The flip side of this is also true: following the “even a blind squirrel will find a nut” hypothesis, a manager with no skill at all can significantly outperform its benchmark over short periods of time.
 
Discerning ability from luck requires long time increments. The more data you have, the less short-term fluctuations will influence your decisions. Even so, trying to separate the wheat from the chaff without understanding how performance was generated can leave you with a subpar result. According to recent research, the average 5-star fund (as rated by Morningstar) has dropped to 3 stars a decade later[1]. Ultimately, selecting investment teams based on sound fundamentals and low fees is of greater importance than simply making selections based on recent performance.
 
We are not suggesting that all active managers outperform their benchmarks net of fees, but we do implore investors to consider their dispersion tolerance and timeframes when selecting a portfolio structure for their assets. If one quarter or one year of underperformance causes agita or, even worse, action, passive management is likely a good choice. It is wiser for an investor to cheaply invest in an index than to chase a “hot dot” – a manager who has outperformed significantly in the immediate past.

If you are relying solely on one-year performance, it is likely you are putting your chances of success no higher than throwing a dart blindfolded. If, however, you can look back over full market cycles, active management may have a place at the table, so long as you are comfortable with the team and can negotiate reasonable fees. Having an independent consultant to help navigate both manager selection and changes to your lineup can help mitigate the number of bad days your portfolio experiences.
 
As always, thank you for spending a few minutes to peruse this issue of Independent Insights. We also recommend that you read our newest issue of A View from the Corner Office in which our CEO, Tom Scalici, gives an update on Cornerstone and opportunities where we help clients engage in the Employee Stock Ownership Plan market. We have been actively supporting ESOPs for many years and are an ESOP ourselves, so it has been an area of growth for our company. For those of you attending tonight’s Project HOME’s 30th Anniversary Gala, we look forward to seeing you there. May there be no need for a 40th in Philadelphia or anywhere else.
 
[1] “The Morningstar Mirage” The Wall Street Journal, October 25, 2017

Kevin Karpuk, CFA Chief Investment Officer

Kevin is Cornerstone’s Chief Investment Officer and is involved with the firm’s Investment Policy and Strategic Planning committees. Kevin joined the company in 2000 after graduating from Lehigh University with a B.S. and M.S. in Economics and earned his CFA charter in 2005. Kevin supports many charitable causes and has established a donor advised fund to propagate his philanthropic interests. Kevin lives in Bethlehem with his cats Zola and Charlyne, enjoys woodworking, gardening, reading and travel. Kevin is the proud uncle to many nieces and nephews and loves spending time with and spoiling them.

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Disclaimer Notice
This material is prepared by Cornerstone Advisors Asset Management, LLC (“Cornerstone”) and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the published date indicated on the article and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Cornerstone to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Cornerstone, its officers, employees or agents. This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

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The information is provided solely for informational purposes and therefore should not be considered an offer to buy or sell a security. Except as otherwise required by law, Cornerstone shall not be responsible for any trading decisions or damages or other losses resulting from this information, data, analyses or opinions or their use. Please read any prospectus carefully before investing.




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