Then it was on to problem No. 3, benchmarking or performance measurement. "Managers with skill suffer from being locked into style boxes," Bernstein argued. "It's extremely constraining and explains the exodus [of managers] from mutual funds to hedge funds."
It makes sense, after all, that if someone is a great small-cap manager, she ought to be able to find investment opportunities in other areas as well. Challenging the so-called style police, Bernstein said that managers with skill should be given as much opportunity to earn returns wherever possible. At the same time, he also remarked that cash was an underrated asset class. Just because it doesn't have a lot of appreciation potential doesn't mean it can't help investors control risk in times of uncertainty.
Moving to the final point recapping his 2003 talk, Bernstein remarked that "long-only is a silly way to manage money," adding that this view of investment management was declining. If a manager is able to spot market inefficiencies that result in undervalued securities, they should be able to identify overvalued ones as well. But if short-selling is legitimate, this student of investing seemed more skeptical about the fee structure of modern hedge funds, calling it only "a means of compensation."
At this juncture, Bernstein turned his attention to his main subject at the JP Morgan Fleming conference-dividends, the forgotten part of total return. For the first time in a long lifetime, dividends today are worth as much after taxes as capital gains. "This event has occurred and no one has noticed" beyond an occasional article, he argued.
Conditioned by their own experience, it's little wonder dividends get no respect from today's investors. Over the last 20 years, capital gains were not only taxed at favorable rates, but they also accounted for the lion's share of total return.
The long-term picture is very different than the current climate, in which dividends still get no respect. Research from famed academic Jeremy Siegel examining stock price history back into the 19th century reveals that, of the 7% long-term real rate of return on stocks only 2.7%, or 39% of the total, came from capital gains.
Bernstein himself was just a babe on Wall Street when, during a powerful 1958 rally, stocks suddenly were yielding less than bonds. In 1929, stock yields came very close to falling below bond payouts, and then the market crashed.
Bernstein's older partners warned that the move was transitory and "couldn't last." In the end, things really did turn out to be different that time. "The move was dramatic, it wasn't just a few basis points," Bernstein recalled. "Then the notion of growth took hold. This was a way to participate in the amazing growth engine of the U.S. economy."
Shortly after the market's seminal move in 1958 came the go-go years of the 1960s, followed by the Nifty Fifty period in the early 1970s. Growth investing was where the action was and, despite several sustained value rallies, it dominated equity investing for the last third of the last century.
"Young people don't remember when dividends really mattered," Bernstein observed. "When I started in this business [in 1951], people lived on their dividends."
A larger question that cuts to the heart of American corporate finance is whether free cash flow should be reinvested or paid out as dividends. "Management says they need the money," Bernstein noted sardonically. But the former U.S. Army captain who spent part of World War II serving in the Office Of Strategic Services (the Central Intelligence Agency's predecessor organization), admits to being stumped in figuring out what they spend it on.