Diversification and Rebalancing. What the past 40 years have taught us

Transcription

1 Diversification and Rebalancing What the past 40 years have taught us

2 A timely look at two timeless strategies The events of 2008 and early 2009 caused many investors to question some long-held beliefs about investing. Major market dislocations sent almost every asset class into a tailspin, leaving many investors disillusioned and suffering significant losses. Two of the most popular theories called into question were the concepts of diversification and rebalancing. Diversification means spreading investments among different asset classes and investing styles rather than putting them all into one particular type of investment. Rebalancing consists of selling off portions of better-performing investments and allocating assets to those that have underperformed in order to adhere to the original allocation. This is easier in principle than in practice but why? Diversification requires that you resist the temptation to chase the market s leaders and abandon its laggards. Similarly, rebalancing is difficult because it demands that you sell portions of your winning investments and put more into your poor performers. Even investors who are familiar with these strategies may not employ them consistently or fully appreciate the impact they can have on a portfolio. To provide a clear, objective viewpoint on these concepts, Lord Abbett conducted an in-depth analysis to study the influence of diversification and rebalancing on investment performance. Inside, you will find details of this study, which examines the impact on a hypothetical portfolio over the past 40 years. Diversification does not guarantee a profit or protect against loss in declining markets. Investing involves risk, including the possible loss of principal. The process of rebalancing portfolios may carry tax consequences. This material is provided for general and educational purposes only, is not intended to provide legal, tax, or investment advice, and does not account for individual investor circumstances. Investment decisions should always be made based on an investor s specific financial needs, objectives, goals, time horizon, and risk tolerance. Consult with your financial advisor before making any investment decisions. NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

3 Diversification and Rebalancing: The Numbers Speak for Themselves Our study covers 40 years of history, beginning January 1, 1972, and ending December 31, It consists of four major asset classes: 1. Corporate bonds (represented by the Ibbotson U.S. Long-Term Corporate Bond Index) 3. International stocks (represented by the MSCI EAFE Index) 2. Large U.S. stocks (represented by the S&P 500 Index) 4. Small U.S. stocks (represented by the Ibbotson U.S. Small Stock Index) For all indexes, we used total returns meaning all distributions were reinvested. We compared the performance of the individual asset classes with two portfolios. Each portfolio consisted of an initial 25% allocation to each asset class with one rebalanced annually to the original 25% allocation, while the other was never rebalanced. Forty Years of Investment Performance: Through Good Times and Bad Growth of $10, * $1,800,000 $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400, : The only year in which all four asset classes declined It was not until 1990 that each diversified portfolio suffered another negative return. During that time period (01/01/ /31/1989), large cap, small cap, and international stocks each suffered two negative calendar-year returns, and corporate bonds suffered five negative calendar-year returns. Had an investor sold out of the markets at that time, the investor would have missed 15 straight years of each diversified strategy s positive returns The worst bear market since the Great Depression Large U.S. stocks % International stocks % Small U.S. stocks % Corporate bonds -0.98% Interest rates climb dramatically higher. Large U.S. stocks 8.13% International stocks 15.97% Small U.S. stocks 28.74% Corporate bonds -1.33% International stocks dominate. Large U.S. stocks 16.49% International stocks 33.85% Small U.S. stocks 11.63% Corporate bonds 13.50% $200,000 $10,000 $ Small U.S. stocks 1 allocation 2 (annually rebalanced) Past performance is no guarantee of future results. Current performance may be higher or lower than the performance quoted. The performance of the indexes shown does not reflect the deduction of fees and charges associated with investment products. Had these been deducted, performance shown would be lower. This historical chart is an illustration of various sectors of the market; however, not all sectors are represented, nor is this an asset allocation recommendation. No investment strategy, including asset allocation, diversification, or rebalancing, can guarantee a profit or protect against loss in declining markets. The process of rebalancing portfolios may carry tax consequences. * Growth of $10,000 is based on a hypothetical investment of $10,000 from 01/01/1972 to 12/31/2011 and includes the reinvestment of all distributions. The investment values do not take into account the effect of taxes or inflation, which can erode the value of an investment over time. If these were taken into account, returns would be lower. Average annual total return is the percentage change in value over the specific periods mentioned, assuming the reinvestment of all distributions.

4 What Did We Learn? Clearly, investors need to understand that diversification and rebalancing do not guarantee a profit or protect against loss in a declining market, and that even a broadly diversified portfolio can and will experience a negative return from time to time. However, investors following a broadly diversified strategy and rebalancing over the last 40 years have experienced some attractive results when compared with the four asset classes individually. Two lessons: 1. Diversification Still Works: The two portfolios delivered attractive risk/return characteristics versus the four asset classes individually (see Summary of Results on next page for details). 2. Rebalancing Makes It Work Better: The rebalanced portfolio finished with approximately $59,000 (about 10%) more than the portfolio that was never rebalanced and did so with less risk The Internet Revolution Large U.S. stocks 28.56% International stocks 13.15% Small U.S. stocks 18.49% Corporate bonds 8.35% The Lost Decade Large U.S. stocks -0.95% International stocks 1.58% Small U.S. stocks 6.30% Corporate bonds 7.65% : It was the worst 10-year period for large cap U.S. stocks since In the first 10 years of this millennium, investors experienced some of the worst market conditions in history, including the Great Recession ( ), the worst since the 1930s Great Depression, and two bear markets ( and ). $1,278,873 $657,200 $597,939 $427,229 $392,824 $292, allocation 3 (never rebalanced) Large U.S. 4 International stocks 5 Corporate bonds 6 1 The Ibbotson U.S. Small Stock Index is an index that tracks a universe of stocks designed to be representative of a broad cross-section of U.S. small cap companies. 2 annually rebalanced reallocates assets each year to the original 25% in each index. 3 never rebalanced consists of an initial 25% allocation to each asset class. 4 The S&P 500 Index is widely regarded as the standard for measuring large cap U.S. stock market performance, and includes a representative sample of leading companies in leading industries. 5 The MSCI EAFE Index is an unmanaged index that reflects the stock markets of 21 countries, including Europe, Australasia, and the Far East, with values expressed in U.S. dollars. 6 The Ibbotson U.S. Long-Term Corporate Bond Index is a custom index designed to measure the performance of U.S. corporate bonds. Time magazine illustrations used with permission. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

5 Annual total returns for asset classes and equal allocation strategies Calendar Year Small U.S. (annually rebalanced) (never rebalanced) LARGE U.S. STOCKS INTERNATIONAL Corporate Bonds % 17.07% 17.07% 18.98% 37.59% 7.26% % % % % % 1.14% % % % % % -3.06% % 35.44% 32.71% 37.20% 37.11% 14.64% % 25.92% 23.40% 23.84% 3.74% 18.65% % 9.84% 10.02% -7.18% 19.43% 1.71% % 16.07% 17.20% 6.56% 34.30% -0.07% % 16.01% 17.78% 18.44% 6.18% -4.18% % 23.50% 27.07% 32.42% 24.43% -2.76% % 1.69% 4.39% -4.91% -1.03% -1.24% % 22.81% 21.39% 21.41% -0.86% 42.56% % 23.27% 28.78% 22.51% 24.61% 6.26% % 6.08% 1.17% 6.27% 7.86% 16.86% % 35.81% 33.45% 32.16% 56.72% 30.09% % 28.83% 26.37% 18.47% 69.94% 19.85% % 5.16% 5.68% 5.23% 24.93% -0.27% % 19.69% 22.69% 16.81% 28.59% 10.70% % 17.22% 14.35% 31.49% 10.80% 16.23% % % % -3.17% % 6.78% % 26.87% 26.49% 30.55% 12.50% 19.89% % 7.13% 6.71% 7.67% % 9.39% % 19.30% 20.87% 9.99% 32.95% 13.19% % 1.68% 3.11% 1.31% 8.06% -5.76% % 27.69% 27.05% 37.43% 11.55% 27.20% % 12.08% 13.73% 23.07% 6.36% 1.40% % 17.79% 18.78% 33.36% 2.06% 12.95% % 13.08% 9.37% 28.58% 20.27% 10.76% % 17.69% 22.95% 21.04% 27.37% -7.45% % -3.45% -6.52% -9.11% % 12.87% % 0.08% 1.93% % % 10.65% % -8.67% % % % 16.33% % 33.46% 42.83% 28.70% 39.17% 5.27% % 14.67% 16.39% 10.87% 20.70% 8.72% % 7.62% 7.01% 4.91% 14.02% 5.87% % 15.52% 16.93% 15.80% 26.86% 3.24% % 3.62% 0.71% 5.49% 11.63% 2.60% % % % % % 8.78% % 22.50% 25.28% 26.46% 32.46% 3.02% % 16.74% 21.51% 15.06% 8.21% 12.44% % 1.21% -1.72% 2.11% % 17.95% Small U.S. (annually rebalanced) summary of results (never rebalanced) LARGE U.S. STOCKS INTERNATIONAL Corporate Bonds Return 12.89% 11.03% 10.77% 9.84% 9.61% 8.81% Risk (standard deviation) 21.71% 12.76% 14.62% 15.66% 17.54% 9.75% # of Positive Years # of Negative Years # of times Best # of times Worst Growth of $10,000* $1,278,873 $657,200 $597,939 $427,229 $392,824 $292,829 Past performance is no guarantee of future results. Current performance may be higher or lower than the performance quoted. The performance of the indexes shown does not reflect the deduction of fees and charges associated with investment products. Had these been deducted, performance shown would be lower. Standard deviation is a statistical measure of the historical volatility of a mutual fund or portfolio. A higher standard deviation number indicates a wider range of returns and a higher degree of portfolio risk. This indicates the number of years that each index had the highest/lowest performance of those depicted over the 40-year period from 01/01/1972 to 12/31/2011.

6 Lord Abbett Funds Domestic Equity Large Cap Funds Taxable Fixed- Income Funds International Funds Domestic Equity Mid/Small Cap Funds Asset Funds Affiliated Calibrated Large Cap Value Capital Structure Classic Stock Bond Debenture Convertible Core Fixed Income Floating Rate High Yield Emerging Markets Currency International Core Equity Calibrated Mid Cap Value Developing Growth Growth Opportunities Mid Cap Stock* Alpha Strategy Balanced Strategy Diversified Equity Strategy Fundamental Equity Growth Leaders Large Cap Value Stock Appreciation Income Inflation Focused Short Duration Income Total Return International Dividend Income International Opportunities Small Cap Blend Small Cap Value Value Opportunities Diversified Income Strategy Global Growth & Income Strategy A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Investments in small and mid-sized companies involve greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations, and illiquidity. Investing in international securities generally poses greater risk than investing in domestic securities, including greater price fluctuations and higher transaction costs. Special risks are inherent to international investing, including those related to currency fluctuations and foreign, political, and economic events. The value of fixed-income securities will change as interest rates fluctuate. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. In addition, bonds may be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Although the Inflation Focused Fund invests in inflation-linked investments, there is no guarantee that the Fund will generate returns that exceed the rate of inflation in the United States over time. The success of the Fund s investment strategies will largely depend on the extent to which the Fund s portfolio management team correctly forecasts inflationary trends and expectations. During periods of deflation or when inflation is lower than anticipated, the Fund is likely to underperform funds that hold fixed-income securities similar to those held by the Fund but do not hold inflation-linked investments. If the Calibrated Large Cap Value and Calibrated Mid Cap Value Funds fundamental research and quantitative analysis fail to produce the intended result, the funds may suffer losses or underperform their benchmark or other funds with the same investment objective or strategies, even in a rising market. The Calibrated Large Cap Value and Calibrated Mid Cap Value Funds are newly organized. There can be no assurance that they will reach or maintain a sufficient asset size to effectively implement their investment strategies. Some funds invest in underlying funds that may engage in a variety of investment strategies involving certain risks; these funds of funds may be subject to those particular risks of the underlying funds in proportion to which each fund of funds invests in them. Performance may be lower than the performance of the asset class that they were selected to represent. No investing strategy can overcome all market volatility or guarantee future results. *Effective March 30, 2012, the Lord Abbett Mid Cap Value Fund changed its name to Lord Abbett Mid Cap Stock Fund. Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at , or visit us at Read the prospectus carefully before investing. Copyright 2012 by Lord Abbett Distributor LLC. All rights reserved. for more information Lord Abbett Client Service Visit us at: Lord Abbett mutual fund shares are distributed by LORD ABBETT DISTRIBUTOR LLC 90 Hudson Street, Jersey City, NJ NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE DIVERSBRO (03/12)