Diversification is supposed to reduce risk and potentially increase returns. This was not the case in 2014. Last year anyone who invested globally underperformed those who invested solely in the US. REITs performed best, followed by Large Company US stocks. Smaller U.S. companies showed negative returns until the fourth quarter. Those who were invested solely in bonds recovered from the 2013 panic and held up well as long as the bonds were U.S. dollar denominated.
The biggest factor impacting investors in 2014 was the strength of the U.S. dollar. This strength hurt commodity and energy investments as well as investments in companies and government bonds outside our borders. Will the dollar continue to strengthen? Will we need to rethink diversification strategies and eliminate investments outside the U.S.? History tells us that limiting our investment universe increases our risk and reduces returns over the long run. Unfortunately the average investor seems to want to chase what has done the best recently, only to be wading in shallow water as the tide goes back out to sea.
Last year, investment in alternative assets worked well in general. REITs were the best performers of 2014. MLPs performed extremely well until the fourth quarter. However, commodities and precious metals in particular suffered as the dollar continued to strengthen. As noted in the graphic above, since 1999 including alternative investments in a portfolio has increased returns by approximately 8% and reduced risk by over 12%. This is not the case every year, but most years. This past year, REIT investors fared better than investors in other alternative asset classes . In fact, someone who invested solely in REITs would have performed better than most other investors. We highly recommend diversifying over being overly concentrated in one asset class however.
The periodic table of returns shows us some interesting tidbits of information. Over the last ten years, emerging market stocks have been the best performing asset class. Last year they were one of the worst performers, only exceeded by commodities. Commodities have interestingly under-performed everything else for three years in a row and have generally lost money for the last ten. Many may remember just a few years ago when everyone wanted to own silver and gold. Those who were concerned about rampant inflation and bought large hoards of gold coins, bars and other items fell victim to what we characterize as the manic depressive nature of markets. Our point is that these asset classes go in and out of favor over time. While we may want to follow the trends in the short run, a strategic investor chooses to make sure that they stay adequately diversified for the long run.
The other take away from last year is that any investments outside the U.S. gave us negative returns in general. Will this always be the case? If we look back to the 80's and early nineties, international investments outperformed U.S. investments by a wide margin. Most of the last decade, emerging markets outperformed U.S. investments as well, but the story has been different the last two years.
In our stock and ETF oriented models we have held a lower non-US allocation and positioned a good percentage into REITs and MLPs, staying away from commodities for the most part in 2014. Our non-US holdings did not help us in 2014, but they did not hurt us either.Someone who could have gotten these reports ahead of time or used a crystal ball could have allocated almost 100% of his or her portfolio to REITs this year or if more cautious owned REITS and large company U.S. stocks. Adding bonds to the mix would have provided more stability as is usually the case (not in 2013 however). We want investors to keep in mind that long term strategic investors do well by sticking to a strategy that has proven to reduce risk and tends to increase returns over the long run.