Market commentary for index investors

Market commentary is an important client communication and marketing tool for investment and wealth managers. Making predictions can be particularly powerful, as I said in “Are financial predictions too risky?”

But what if you’re in the camp of index investors—or similar strategies, such as evidence-based investing—or if you simply don’t believe in market timing? You may skip market predictions on principle, as my friend, writer Wendy Cook, suggested in conversation with me. You won’t say which asset class will outperform next. Nor will you predict the meeting-by-meeting decisions of the Federal Open Market Committee and how they’ll affect stocks, bonds, and interest rates.

Index investors can’t totally avoid predictions

You can’t totally avoid predictions, in my opinion, when you communicate with the clients for whom you manage money. You just make a different kind of prediction than your peers who rejigger their portfolio holdings and asset allocations as their predictions change.

For example, index investors may predict that the current trendy asset class—or investing in high-fee, actively managed portfolios—will not pay off over the long term. You may also encourage investors to “stay the course” based on historical evidence. This helps you convince investors to stick with their current asset allocations until their personal circumstances change. This kind of prediction focuses more on long-term truths backed by the historical record. It’s part of active managers’ predictions, too, but to a lesser extent.

You’re trying to solve your investors’ challenge of “Consuming financial news without being consumed by it,” as Wall Street Journal columnist Jason Zweig points out in a blog post recommended to me by Wendy Cook.

Index investors still need commentary

If you manage an index fund, you need to put fund performance in perspective. Your investors want to know why returns were positive or negative. They may also care about why your fund performed the way it did relative to your index and the broader market. Relative performance is particularly important when your fund performance differs greatly from your index.

This means discussing what drove the fund’s performance, which could include:

• Individual stocks that outperformed or underperformed—while you’re not a stock picker, telling the story of your fund’s best- and worst-performing stocks gives insight into what drove performance during the period.
  
• Factors influencing the index’s performance during the period—for example, if you run a value-oriented index fund, your fund’s performance will suffer relative to broader or growth indexes when growth stocks outperform.
• The way that your fund attempts to capture index performance—your fund probably doesn’t invest in every single stock in your index in the exact same proportions as the index. Portfolio holding differences can make performance diverge from the index.
• Your fund’s cash position and inflows or outflows—if your fund’s positioning differs from the index, it won’t perform like the index.
• Fees and expenses—one can’t invest directly in an index. Funds have expenses, such as management fees and transaction costs, that cut into their ability to achieve index returns.

If you’re an advisor using index funds

If you’re an advisor using index funds, you may share commentary from your fund providers with your clients.

To get the most mileage out of sharing that third-party commentary, add your personal observations. For example, “The strong performance of ASSET CLASS, which underperformed dramatically last year, reminds us of the value of staying fully invested.”

I believe index investors need commentary, even if they’re invested for the long term, with little change in their allocations. What do YOU think?

Image courtesy of hywards/freedigitalphotos.net