Connecting Quarterly: 1st Quarter 2016

Dear Friends,

In the mid-1800s, having a child was a remarkably dangerous activity for a woman.  Five out of every 1,000 women died during deliveries performed by midwives or at home.  Even more astounding was the fact that when doctors in hospitals performed deliveries, the maternal death rate was 10 to 20 times greater.1  The cause of most of these women’s deaths was a condition called puerperal fever, commonly referred to as childbed fever.

For years, the childbed fever epidemic frightened childbearing women.  The medical community produced a number of unsuccessful theories such as:

  • In midwives’ clinics, women gave birth on their sides, while doctors had women give birth on their backs.  Thus, some hypothesized, turning women on their sides must be the answer.
  • After a woman died in a doctor’s clinic, a priest would typically walk past all of the women’s beds ringing a bell.  Perhaps the sight of the priest and the sound of the bell was terrifying the birthing women so badly they got sick and died?2

This time period was also the “start of the golden age of the physical scientist”, when physicians were expected to embrace scientific training.  Dr. Ignaz Semmelweis was a Hungarian doctor who, after years of frustrating research, stumbled on an important difference between the activities of doctors and midwives.  Doctors typically delivered babies in the afternoon, after having spent their mornings performing autopsies of the women who had died the day before.  Meanwhile, midwives had no such autopsy responsibilities. Semmelweis hypothesized that the doctors were unintentionally communicating the disease from the deceased to the delivering mothers.

Semmelweis found that the doctors could dramatically increase the survival rate of new mothers simply by the doctor washing his hands prior to delivery.  Today, this conclusion seems incredibly pedestrian, but at the time the medical community saw it as anything but.  In part due to Semmelweis’ lack of tact and his propensity to publicly disparage those who disagreed with him, many of his fellow doctors refused to acknowledge his finding.  In fact, his colleagues were outraged at Semmelweis’ suggestion that they were the cause of their patients’ horrible deaths.  It wasn’t until decades later that the medical community would embrace Semmelweis’ simple instruction:

“Wash Your Hands”

In the financial markets, most investors have a desire to achieve “above-average” returns on their assets.  Exorbitant amounts of time and money are spent on exotic investment strategies that suggest they will produce peer-beating returns.  Investment managers that have generated past outperformance of 100 basis points (1%) a year are often labeled “the smart money” and those rare few that have bested their peers by 2% are hailed as “gurus” by the financial media.  Yet many studies show that the vast majority of these once highly sought-after stock pickers and market timers fail to repeat their past success.

Despite this evidence, investors commonly repeat this cycle of hopeful investment followed by frustrating results.  But there is an approach which has shown to improve returns relative to one’s peers without having to try to pick tomorrow’s hot investment manager:

“Let Markets Work”

Like Semmelweis’ three words, this advice seems remarkably simple.  But the benefits of being patient and letting markets work for you is supported by compelling evidence:  For the 10 years ended March 31, 2016, the Vanguard S&P 500 Index Fund produced an annualized return of 6.9%.  Over that same time period, the return that the average investor earned from his or her investment in that same fund was only 4.5%.3  This difference shows that over the past 10 years those investors, professional portfolio managers and hedge funds that bought and sold the fund at different times based on their market forecasts in hopes of producing market-beating returnsactually did the opposite.  Making matters worse for these investors, they may have paid significant fees to their advisor/manager for this poor-performing advice.  At the same time, the simpletons who bought the fund and did nothing other than reinvest each dividend when it was received turned out to be “above average” performers when compared to their market-timing peers.

Make no mistake, simple isn’t easy and thoughtful guidance is often required to stay the course in turbulent times.  It took decades for Dr. Semmelweis’ peers to accept the science that saving the lives of birthing women could be no more complex than washing one’s hands.  Similarly, it’s hard for most investors to believe that “sitting still” with a low-cost, diversified portfolio is an investment approach that generally outperforms the complex and expensive strategies that are continuously hawked by many investment managers and advisors.  But just like in the medical profession, if we put egos and mythology aside and look objectively at the evidence, we see that often times simpler is, in fact, better.

It seems clear to us that the recipe for investment success has less to do with the investment selection and more to do with the investor behavior.  As John Bogle, founder of The Vanguard Group, once said:  “One half of your return is determined by your investments, the other half by what kind of person you are.”

We welcome your thoughts and comments.

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Chuck Carroll, CFA, CAIA
Chief Investment Officer
TFO Phoenix, Inc.

1″In 1850, Ignaz Semmelweis saved lives with three words: wash your hands”, by Dr. Howard Markel, PBS Newshour, May 15, 2015.

2″The Doctor Who Championed Handwashing And Briefly Saved Lives”, by Rebecca Davis, NPR, January, 12, 2015.

3Morningstar, March 31, 2016.