Gregg S. Fisher’s background makes him something of an odd duck in the mutual fund world. While most fund managers devote their education and professional careers to security analysis, Fisher, who holds both certified financial planner (CFP) and chartered financial analyst (CFA) designations, has built his 20-year career around managing portfolios for individuals and financial advisors. Talking with clients, he says, helps keep him grounded about how human foibles can influence investment decisions.
“Investors often tend to run to securities that already have risk priced into them,” says the 43-year-old founder of Manhattan-based Gerstein Fisher, which manages $2 billion in client assets and serves as advisor to the three Gerstein Fisher mutual funds. “They are human beings subject to emotions and judgmental biases.”
Such “crowd mentality” and other predictable, potentially damaging behavioral patterns among investors form the centerpiece of his firm’s investment strategy. Studies show that investors tend to conclude that the recent past performance of a stock or an entire market will continue far into the future—or they wrongly equate a good company with a good investment, regardless of price. Conversely, they often ignore areas of the market that haven’t performed well lately, and pile into those that are already popular. Fisher avoids buying into areas of the market that have become overheated because of such emotional pitfalls, and zeros in on more overlooked stocks or asset classes that he believes have better return potential and lower risk.
Go Abroad, Keep Bond Maturities Short
Right now the human tendency to focus on past returns may be leading many investors to ignore the interest rate risk in long-term bonds, he says. Indeed, those past returns have been impressive. According to a study the firm conducted earlier this year, long-term government bonds produced an annualized return of 7.59% between 1998 and 2013, compared with just 4.75% for the S&P 500 index. And the outperformance came with one-third less volatility than the index. During the longer period of generally falling rates between 1982 and 2012, longer-term bonds outperformed short-term bonds by a healthy margin.
Fewer people remember the long stretch of time when short-term Treasury bills outperformed longer-term bonds between 1956 and 1981, when rates were generally rising. According to the study, the “sweet spot” for investing in both rising-rate and falling-rate environments between 1956 and 2012 appears to be five-year Treasurys. Between 1956 and 1981, when rates were on the rise and short-term securities fared best, five-year Treasurys underperformed one-month T-bills by just a small margin. During the falling-rate period between 1982 and 2012, their annualized return lagged long-term bonds by roughly 2.6 percentage points. But on a risk-adjusted basis, using standard deviation as a measure, five-year Treasurys looked substantially better than longer-term bonds.
Applying those findings to today’s environment, Fisher believes that, going forward, investors should view bonds as a way to reduce risk in portfolios, not as high yield or high total return generators. With that in mind, he advises sticking with government and investment-grade securities and keeping maturities at five years or less.
“Given the steep yield curve between three-month Treasury bills and five-year Treasurys, it makes sense to tilt toward the five-year bonds right now,” he says.
Staying at the shorter end of the yield curve is just one way Fisher plans to address the risk that the ongoing debt ceiling debate poses to clients’ bond portfolios. “With short-term bonds maturing relatively frequently, hard assets such as gold, commodities and global real estate, and exposure to international high-grade sovereign debt denominated in non-dollar currencies, we feel our bond portfolios are well-positioned to minimize the potential volatility associated with a flight from U.S. government securities,” he noted in a recent letter to concerned clients.
The tendency to look backward to predict future returns is also causing many investors to overlook or underinvest in foreign stocks and bonds, he says. Although the U.S. stock market has outperformed most foreign markets for nearly three years, Fisher believes this is likely a transient phenomenon. Between 2003 and 2012, the U.S. market placed in the top five among 24 developed-nation markets in only two years. In seven of those 10 years, the U.S. market placed in the bottom half of those countries.
Over longer time periods, global diversification looks even better. When the firm measured returns for global versus domestic-only portfolios between 1997 and 2012, it found that the global portfolio outperformed 68% of the time over 157 three-year rolling periods. As the investment time horizon extended to 10-year rolling periods, the global portfolio beat the U.S.-only portfolio 100% of the time.
“Despite a trend of rising correlations among global stocks, different markets still react to local factors such as differing monetary and fiscal policies, inflation rates, interest rate environments and business cycles,” noted a report from the firm issued earlier this year. “The recent strong performance of the U.S. stock markets has caused many American investors to feel anxious about international investing and to question the merit of globally diversified portfolios. We believe at some point other global asset classes will take the baton from domestic stocks.” Thus, foreign stocks and bonds account for about one-third of the assets in client portfolios at his firm, he estimates.
Although the bulk of the firm’s $2 billion in assets under management is in individual accounts, Fisher is looking to attract an even broader audience through three mutual funds. The oldest and largest of these is the Gerstein Fisher Multi-Factor Growth Equity Fund (GFMGX), which will celebrate its fourth birthday in January and has about $170 million in assets. Its annualized return of 17.75% over the three years ending September 30 stands up well against the 15.27% return for the average fund in Morningstar’s large-cap domestic growth category over the same period. Two other funds—the Gerstein Fisher Multi-Factor International Growth Fund (GFIGX) and the Gerstein-Fisher Multi-Factor Global Real Estate Securities Fund (GFMRX)—are smaller and have track records of less than two years.
Fisher uses quantitative analysis for all of its funds to sift through data and find securities that meet its investment criteria. The screens often lead to “tilts” against benchmark indexes in favor of characteristics that history shows tend to enhance returns. These include a preference for smaller companies within a particular investment universe, growth stocks with some value characteristics and stocks with positive recent price momentum.
“The process allows us to make investment decisions based on relationships that are backed by research and data, not emotion or gut feelings,” he says. “By filtering information mathematically instead of qualitatively, we avoid common emotional pitfalls of investing and have the potential to capitalize on common investor behavioral biases that influence market returns.”
Multi-Factor Growth’s smaller stock tilt is apparent in its $18.5 billion average market capitalization, compared to $44.2 billion for the Russell 1000 Growth Index and $60 billion for large-cap growth funds in Morningstar’s database. To ensure that no security holds too much sway in the portfolio, no stock may account for more than 5%. Like other quantitative funds, this one spreads its bets widely. The top 10 holdings account for a modest 20% of assets, and the portfolio holds more than 250 securities.
The $95 million Gerstein Fisher Multi-Factor International Growth Fund, launched in January 2012, applies similar quantitative methods. Like its older and larger fund sibling, it also leans toward the smaller side of the stock world with an average market capitalization of $19.5 billion, compared to $34 billion for its benchmark, the MSCI EAFE Growth Index. For the year ending September 30, its 28% total return beat that of its average foreign growth stock peer by 10 percentage points.
The youngest of the funds, Gerstein Fisher Multi-Factor International Real Estate, hit the market in April of this year. Fisher says the offering fills a gap for most investors, who generally have very little exposure to commercial real estate, particularly in foreign markets. “I don’t know how well REITs will do over the next year or two, but I do believe this is an important asset class to have exposure to over the long term,” says Fisher. “People often think they have exposure to real estate through their homes, but commercial real estate is a very different animal.”
All of the funds, as well as individual portfolios that are in taxable accounts, employ tax-loss harvesting to limit the tax bite for investors. This tax awareness has its roots in Fisher’s experience as a teenager during the 1980s, when he helped his uncle, Ed Gerstein, prepare tax returns for his clients. “I noticed how deeply taxes ate into investor profits, even when they used a financial advisor,” he says. “Tax-advantaged investing can add up to one full percent to returns per year on an after-tax basis. When compounded over time, this can make a huge difference in bottom-line investment results.” As a tribute to Mr. Gerstein’s contributions to his education on taxes and other financial matters, Fisher put his uncle’s name on the door when he founded his firm in 1993, at age 22.