CSS’ Balanced Fund (BF), and in particular, its equity investments, has materially underperformed its benchmarks for the past three years. This recent underperformance has resulted in the BF falling below its 10-year benchmark.
As CSS members ourselves, and being a group of people who care deeply about delivering the best for our members, we understand some of you may be disappointed in the BF’s recent underperformance; however, it is important to know that we feel confident that this is a temporary phenomenon and not a reason to significantly alter CSS’ long-term, successful investment approach.
Before discussing our recent underperformance in more detail below, it is important to recall the investment principles and philosophy that has made CSS such a successful and well-respected Plan over the long-term.
Generally speaking, the Plan’s investments, although diversified across various investment approaches and styles, are purposefully biased toward those styles which are willing to sacrifice some returns in up markets to provide more protection in down markets. Our style leads us to invest in equities biased toward value, quality, smaller size, and lower volatility characteristics, which academic and empirical market research continually demonstrate outperform relative to alternative portfolio choices over the long term.
This defensive investment profile is intended to provide a less bumpy ride (less volatility), outperform alternative portfolios over the long term, appeal to a typical defined contribution (DC) pension plan investor, and be consistent with the Plan’s fiduciary responsibility to prudently protect our members’ accumulated investment capital.
CSS members who have been with the Plan for the last 20 years or more will recall that it was this investment philosophy that significantly benefitted the Plan and its members in previous difficult market environments – namely, the Tech Bubble in 2000 and the Great Financial Crisis in 2008 – all the while outperforming the Plan’s longer-term benchmarks.
In recent years, we’ve seen the equity investment characteristics favoured by CSS lag the broader market. For example, growth stocks have outperformed value stocks by about 16% on average annually over this period. Apple, Microsoft, Amazon, Facebook, Tesla, Alphabet Class A (Google), and Alphabet Class C (Google) are now the largest stocks in the S&P 500 index. The top five stocks account for about 20% of the entire market and top eight stocks about 25%. Each of these companies has had triple-digit returns over the last number of years, and in 2020 their returns ranged from a low of 28% to a high of 730%. As a result, measures of market concentration in the U.S. are at 40-year highs and stock prices relative to earnings are at the second-highest level in recorded history, only exceeded during the Tech Bubble in 2000.
The current market environment, despite some differences, is looking more and more like other times in history when asset bubbles emerged and investor mania and speculation ruled the day (examples include 2008, 2000, 1989, 1973, 1929). Overall, recent market participant behaviour is demonstrating signs of a valuation bubble: skyrocketing stock prices (Tesla up 730% in 2020); equity valuations at extreme levels (currently second-highest in recorded history); highly speculative investing by non-professional investors (Gamestop); and a belief that certain stocks are so good that the price you pay for them doesn’t matter. We do not know what the future will hold and certainly cannot predict if or when a significant market correction might occur, but we believe it prudent to maintain our focus on optimizing the long-term financial retirement outcomes of our members rather than short-term market phenomenon.
Our choice has been to continue to rely on those investment principles and philosophy that have served the Plan very well for a very long time: 1) utilize sound and prudent investment approaches supported by academic and empirical research, 2) employ investment styles and diversification principles that help protect and preserve our members’ capital, 3) be disciplined in adhering to our investment principles and always being mindful of the long-term investment horizon. This disciplined approach has in the past, and we expect will do so in the future, helped us to look past shorter-term volatility and market anomalies.
It certainly doesn’t feel good to endure underperformance for any period of time and it can make you doubt your convictions, but we remain confident that our investment approach continues to provide the best likelihood of optimizing long-term members’ CSS investment returns and thereby their financial retirement outcomes.