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Equity Perspectives

Investors might do well to examine how asset classes perform over a full market cycle. 

The meltdown in financial markets that accompanied the 2008–09 financial crisis now seems like distant history. But history plays a pivotal role in how investors evaluate the performance of asset classes, so it may be worth examining just how the recent five-year anniversary of the crisis—and the attendant losses in equities and fixed income—are factored into current measures of the markets. As it turns out, timing is everything.

As the market disruption that began in late 2008 fades into the past, so does the impact of the negative performance of that time period. In assessing current five-year performance numbers, for equities and fixed income, the starting point begins near the bottom of the market, in March 2009. By March 2014, five-year performance returns will only capture the market rebound from that bottom.

For a dramatic example of how much depends on an investor's point of reference in measuring market performance, consider the trajectory of the S&P 500® Index since the start of 2008, a period of five years and 10 months. As 2008 began, the equity market was still not that far removed from the record highs set in October 2007. Things began to fall apart as the first tremors of the financial crisis began to be felt, and by September 2008, when Lehman Brothers declared bankruptcy, the market was in full-on panic mode.


 

Chart 1. Performance: What a Difference 10 Months Makes
Price of the S&P 500® Index, January 2008 through October 2013

Source: Bloomberg and Standard & Poor's.
For illustrative purposes only and does not represent any specific Lord Abbett mutual fund or any particular investment.
Past performance is no guarantee of future results.
The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Performance during other time periods may be different or negative. Investors may experience different results. Due to market volatility, the market may not perform in a similar manner in the future. Please refer to "Important Information" regarding the economic indicator data in these charts and index information.


If we compare the return of the broad equity market since the start of 2008 (five years and 10 months) to the 60-month interval, we will see drastic differences in five-year average annual returns. The S&P 500 Index returned 15.17% on average over the five years through October 31, 2013, according to Bloomberg data. (That's what happens when a period of declining prices "rolls off" a price chart, leaving the market trough as the start of the comparison period.) However, if we go back to the start of 2008, incorporating the sell-off that began in September of that year, the average annual return drops to 5.42%.

Clearly, the same would hold true for below-investment-grade fixed income, as Chart 2 shows. For example, regarding leveraged loans and high-yield corporate bonds, we find that the average annual returns drop, respectively, from 10.58% and 18.11% in the five-year period October 31, 2008–October 31, 2013, to 5.00% and 9.78%, respectively, when including all of 2008 (according to Morningstar data). This shift effectively cuts investor returns in half by changing the time period by 10 months.


 

Chart 2. "Roll-Off" of Financial Crisis Losses Has Boosted Five-Year Returns for Equities and Fixed Income
Annualized returns in select equity and fixed-income categories

Source: Morningstar.
*01/01/2008 – 10/31/2013.
**10/31/2008 – 10/31/2013.
1 As represented by the Credit Suisse Leveraged Loan Index.
2 As represented by the BofA Merrill Lynch High Yield Master II Constrained Index.

For illustrative purposes only and does not represent any specific Lord Abbett mutual fund or any particular investment. Past performance is no guarantee of future results.

The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Performance during other time periods may be different or negative. Investors may experience different results. Due to market volatility, the market may not perform in a similar manner in the future. Please refer to "Important Information" regarding the economic indicator data in these charts and index information.

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.

Floating-rate (or leveraged) loans are lower-rated, higher-yielding instruments, which are subject to increased risk of default and can potentially result in loss of principal. Bond prices move inversely to interest rates: when interest rates rise, bond prices fall, and when rates fall, bond prices rise. With floating-rate loans, the opposite is true: loan prices tend to move in the same direction as interest rates; when short-term interest rates rise, loans pay higher income, and they pay less when rates fall. High-yield securities carry increased risks of price volatility, illiquidity, and the possibility of loss in the timely payment of interest and principal.


What should investors take away from all this? They would be wise to look back further than five years when considering performance assessments. They want to make sure they are evaluating their investment options over a full market cycle. For instance, during the market downturn in 2008, more than 50% of active managers outperformed the market based on their benchmarks, according to research from Axioma and Morningstar. With an emphasis on fundamentals and active credit research, these active managers were able to provide investors with lower downside capture during the market fall. By either moving away from the riskier segments of certain asset classes, such as less fundamentally sound stocks and lower-rated loans and high-yield debt, or by selectively choosing heavily researched companies in those areas, these active managers were better prepared for the market downturn and their investors were rewarded accordingly. Of course, there is no guarantee that actual managers will outperform the market in future market cycles.

Currently, five-year performance numbers provide little insight into similar environments; they mainly show the ability to capture strong returns when the market is rising. While examining the performance of asset categories over a fixed time period can be useful, charting the performance over a full market cycle may be more instructive. The same holds true for actively managed portfolios, as a longer view of a portfolio's record that includes up and down markets will give greater insight to how its managers navigate a more difficult market. 

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