Take Managers' Gloomy Forecasts With a Grain of Salt

Being gloomy is in.

That was one of my key takeaways from last week's Morningstar Investment Conference, when everyone from DoubleLine's Jeffrey Gundlach to Artio's Rudolph-Riad Younes weighed in with dark prognostications about the U.S. deficit and the global economy. Even if you didn't make it to our conference, you know there's no shortage of hand-wringing in online forums and on CNBC.

But before you adopt the bear view for your portfolio, it may be helpful to consider the doomsayers' motives and how a pessimistic outlook is manifesting itself in their portfolios. Or not.

Give the People What They Want
For starters, let's think about what we've all been through in a single decade: two recessions, one of them the deepest since the Great Depression, and two major bear markets. Losing money is top of mind for everyone right now, so anyone in the financial-services industry with a pessimistic world view won't have to look too hard to find a receptive audience. And as any good salesperson knows, it's a lot easier to sell a message that people want to hear than one they do not.

Where's the Career Risk?
In addition, pointing out all that could go wrong has the net effect of making the prognosticator look sober and prudent, very desirable attributes after a couple of decades' worth of tomfoolery in the financial-services industry.

And from a practical standpoint, being bearish carries a lot less career risk, at least right now, than sticking your neck out with a more positive outlook. (Whether that pessimism manifests itself in their portfolios is a separate matter, as I'll discuss later.) If a manager is out there saying bearish things about the economy and the market plummets, he'll be lauded for his prescience. And if the market goes up, what's the worst that can happen--clients don't gain as much as they otherwise would have?

Opportunity cost is not a commonly tracked measure on Wall Street, whereas it's easy to measure whether your bullishness ended up losing clients money. No one wants to be like Paul Meeks, who yelled "Let's get ready to rumble!" upon the launch of the Merrill Lynch Internet Strategies fund at the peak of the dot-com bubble. Right now the risk of being bearish and getting it wrong is a lot less than the risk of being bullish and wrong.

Of course, the career risk is based on the market cycle. When I started at Morningstar amid a bull market in full swing in the early 1990s, the career risk for professional investors was, emphatically, in the realm of not keeping up. Managers who dared to articulate the naysayer viewpoint, or worse yet, incorporate it into their portfolios, were told to knock it off or were even fired if performance suffered enough. By the time the late 1990s rolled around, being anything but fully invested in stocks was a one-way ticket to career suicide for investment managers.

Do As I Say, Not As I Do
That brings me to my next point: The 1990s advent of style purity means that even if managers are feeling dour about the market these days, you're not likely to see it show up in their portfolios, at least not most retail mutual funds. While a handful of managers incorporate their less-than-sanguine top-down views in their portfolios, such as FPA's Steve Romick, many managers do so in a very limited way, if at all.

Instead, most operate within fairly narrow asset class structures, if not by prospectus then by custom. Despite investors' newfound zeal for tactical asset allocation, most managers ceded any responsibility for delivering all-weather performance more than a decade ago. (Granted, much of this move was driven by investors and advisors, who claimed they wanted to exert more control over their asset mixes rather than allowing their managers to do it for them.)  

For example, while Younes sounded nearly as pessimistic as did Romick during the pair's discussion at the Morningstar conference, Younes acknowledged that he didn't have broad latitude to hold cash or buy gold for his portfolio. (Holding a 10% gold stake, Romick quipped, is akin to buying an insurance policy for just the bathroom of your house.)

Of course, it's possible to be pessimistic about the economy but still find stocks to buy. But I can't help but feel that many managers have the best of all worlds: the ability to opine about the economy's sad state of affairs, thereby earning props for being a sober realist, without having to position their portfolios to defend against it.

That's not to suggest that all managers should embrace more free-wheeling mandates because the aggregate records of managers who are allowed to be opportunistic aren't all that hot. Romick has done well, as have Research Affiliates' Rob Arnott, BlackRock's Dennis Stattman, and a handful of others. But many other more active, opportunistic managers have not distinguished themselves.  Vanguard Asset Allocation  is the most recent example of an active fund that has gotten caught leaning the wrong way, but it has many forebears. Consider this: Morningstar used to have an entire asset-allocation category dedicated to managers who actively jockeyed among asset classes. As the bear market wore on and holding anything but stocks was not rewarded, however, we found that most managers used fairly static stock/bond mixes. We eventually dropped our asset-allocation category altogether.

What Am I Supposed to Do With This?
My last point on why it's a mistake to take professionals' bearish prognostications to heart is that translating a bear view to an investment portfolio doesn't leave you with a particularly appealing set of investments right now. Bond yields are pathetic, and gold is arguably in a bubble. Barring an Armageddon scenario that drives the prices of those securities even higher--and I guess anything's possible--it's tough to see those asset classes delivering enough upside potential to get investors to their goals.

I'm not saying that you can't agree with the pros who think there's plenty to worry about. Nor do I mean to argue that some professional investors' bearishness is a contrarian indicator, ergo it's time to pile into stocks. Rather, my point is that professional bears may have their own interests at heart even more than they do yours.

See More Articles by Christine Benz

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