Saturday Night Bingo: The Lie Behind "Balanced" Funds

A straight-shooting look at why traditional balanced strategies are leaving individual savers relying on luck.

B14!!! Echoed across the Lion’s Club main hall.

Gladys stabbed her blotter smack in the middle of the square.

I30!!! Screamed out of the mic.

This time, Gladys drove the blotter straight into the heart of that square.

One more. That’s all she needed. And then it happened.

N44!!! BINGO!

Gladys won. Finally. She was the winner of the local Saturday Night Bingo Game at the town hall. Weeks, months, and years have passed since she last won. The win was energizing, exhilarating, and outright euphoric. This win would be talked about for a long time. Her friends couldn’t believe her string of bad luck. After all, they were winning on a regular basis – but not Gladys. Luck just didn’t seem to run her way.

But that was now over. Maybe her luck has finally changed for the better.

The next day, she received her investment statement. Her bad luck returned.

* * * * *

The investment industry is very good at taking your savings, throwing them into a fund or strategy of some kind, and then taking credit for all of the success. The industry will always claim investment success is attributed to its amazing skillset of stock-picking, manager selection, or a proprietary model that virtually confirms these individuals and managers actually do walk on water.

Unfortunately for these self-proclaimed genius investment advisors, investment failure also occurs on a regular basis. Seemingly, every 10 years, stock markets do the stock-market thing and crash by up to -50% or more.

Of course, when this happens, the investment industry will always claim “no one saw this coming”, and “let’s review your objectives and stay invested for the long haul.”

In addition to this dogmatic or tunnel vision way of life, the investment industry has also adopted the wisdom that every investor on the planet should be viewed as a pension fund.

This is where the industry failed families and individual investors such as Gladys.

Put another way, by treating you as if you are a pension fund, the industry believes you will live forever, and you are insensitive to losses.

Yes, pension funds do live forever or a time period much longer than any one of us. In addition, if a pension experiences an investment loss – it’s really not that big of a deal.

For example, if a pension fund returns -20% for the year, while its benchmark portfolio returns -25%, the pension fund managers view this as an outstanding success. After all, they lost LESS money than they may have otherwise lost. This success is celebrated with bonuses, year-end parties with nice food and bubbles. And – no one loses their job.

Gladys, however, certainly will not be celebrating.

If she loses -20%, she will be devastated.

She will not celebrate at a party with bubbles and nice food. She certainly will not reward herself with a bonus or vacation. Instead – she’s hurt financially and emotionally.

As individuals and families, we are much more sensitive to losses than to gains. This includes both financial and non-financial.

Yet, the investment industry believes individuals and families do not react to losses.

This is where the industry has failed individuals and families.

We are not pension funds. We do not celebrate losing less money than we may have otherwise lost if we invested differently.

Contributing to this gross mismatch of industry results versus investor sensitivities is the industry’s inability to be thoughtful.

Thoughtful in the investment world is the ability, willingness and curiosity for that constant search for non-linear investment experiences.

And if you try to be thoughtful in the Canadian investment industry, you’ll be summoned to the corner office and asked to leave.

Stay in your lane. Collect people’s money and throw it into equity and bond funds. Do this for 25 years, and the investment advisor is rewarded with wealth.

This worked in the 80s, 90s, and 00s. In fact, it worked like magic.

Yet there was no magic, skill, or even thoughtful thinking – instead, investment success during this 30-year period was driven by the most powerful investment wave known to mankind – declining long-term interest rates.

When long-term interest rates decline, bond prices rise. And in the early 1980s, long-term interest rates peaked at nearly 20% in some markets.

And then, long-term rates began a relentless 30-year march towards 0%, reaching this in 2010.

With long-term rates declining from 20% to 0%, bond funds became the best investment ever created. They consistently pumped out 6,7,8% returns and rarely lost money.

It was the PERFECT investment for low-risk, conservative investors.

And it was also the PERFECT addition to equity investors who wanted to reduce their overall risk and volatility.

It was so perfect, the global investment industry used this combination to create the Balanced Fund and to this day, it has become the bedrock, the starting point and the nirvana for investors everywhere.

Walk into a bank and ask for investments – a Balanced Fund is thrown on your lap.

Meet with an advisor – a strategy of stocks + bonds is sold to your unsuspecting soul.

Ready to select the investment strategy for your Group RRSPs or Defined Contribution Pension Plan – no sweat, the target date/balanced fund is jammed up your a**!

However, in 2010, this nirvana ended. It is never coming back, and the industry has failed to inform Gladys and other investors.

The reason for failure is due to simple mathematics – once interest rates hit 0%, there are simply no more interest rates left to cut, and long-term rates had nowhere else to go either.

Naturally, policy makers, led by our central banks, also knew this. And they also knew if interest rates started to rise again, it would be the death of the bond market, as well as banks and insurance companies, and the housing market that DEPENDED upon on a financial and economic world that had never experienced higher interest rates.

So, what could central banks do? For the first time in the history of modern banking, they implemented Quantitative easing and money printing strategies. And they also implemented zero interest rate and negative interest rate policies.

These are absolutely unorthodox monetary policies. And the fact that all of the world’s major central banks adopted and agreed to these new approaches is telling.

While some claim central bankers saved the financial world, others claim central bankers simply delayed the inevitable – a crisis in the bond market.

And this is where Gladys and her bingo-playing friends come back into the story.

* * * * *

Gladys and her friends and spouses all worked hard and were diligent savers. Like many Canadians, none of them worked fancy jobs with big fancy paychecks and bonuses. Yes, they were homeowners, yet their homes were their homes, and their homes provided no liquidity. They lived off CPP and OAS and supplemented this income from their investments.

Their modest lifestyles were dictated by their modest incomes.

And when you wrap all of these modesties together, it creates a conservative, low-risk investor.

And as we shared earlier – the industry’s vision of conservative, low-risk investments is dominated by the belief that because bonds have been conservative, low-risk investments for nearly 40 years, bonds will always be conservative and low-risk.

The industry is about to be proven wrong. It is our view that bonds are no longer conservative investments, and low-risk investors are about to experience some unpleasant experiences.

And while this is happening, the industry will claim – no one saw this coming, let’s review your objectives and hang in there for the long haul.

Put differently – the industry always wins, while investors like Gladys and her friends will lose.

How did this happen? Why do we view this as a high-probability event?

For starters, 30 years of declining rates, amplified by another 10 years of zero interest rates, negative interest rates and quantitative easing, completely erased even the most remote opportunity for the Canadian investment industry to suddenly become thoughtful investors.

This fantasy-world financial conditions encouraged bond funds to invest in riskier and riskier bonds. After all, with low interest rates, THE only way for bond funds to at least have the opportunity to generate acceptable returns for Gladys and other low-risk investors was to slowly take on higher and higher risk, through credit.

Followers of the podcast will agree that IceCap Asset Management was one of the first to warn investors of the risk in private credit and other bond market strategies.

Going forward, a few of the major risks in the bond market have been resolved. Our view remains – low-risk, conservative investors have a very high probability of experiencing losses and unpleasant experiences with their investments.

There is good news.

There are ways to reimagine the balanced fund. Create a portfolio positioned to protect against rising bond market risk and to take advantage of new opportunities developing right before our eyes.

Gladys and her friends will have an opportunity to sleep well and play BINGO again.

~KD