Buy-and-hold investors could find themselves left behind

By Andrew Fishman

Published: April 30 2009 03:00 | Last updated: April 30 2009 03:00

The destruction of more than 12 years' worth of investment gains during a painful 18-month period calls into question the once unassailable investment precept of "buy and hold". With the economy showing no significant signs of rebound, it could take a long time of buying and holding to make an investor whole again.

Witness Japan, where the stock market is still, 20 years later, crawling out of its own economy-induced malaise with share prices less than 25 per cent of their highs. Similarly, it took 25 years for US investors to erase losses suffered during the Great Depression.

Set against that history and today's market realities, I believe buy and hold should be reconsidered and re-analysed. Portfolio construction should include more than buy-and-hold strategies. In fact, for many investors, a portfolio weighted toward "active trading" strategies could result in safer, more liquid, more diversified and less correlated investment approaches, especially when viewed on a risk-adjusted basis.

I recognise that my hypothesis would probably not be supported by Jon Bogle, Jeremy Siegel or other luminaries who believe so staunchly in the value of a portfolio designed around a buy-and-hold strategy. However, active trading has fared well during the past 20 years, and particularly the past 24 months. Often referred to as "day trading", the strategy has evolved considerably since its ubiquity in the late 1990s and now includes professional traders engaged in manual and computer-driven models that aggressively analyse real-time market movements.

I am not advocating the elimination of buy- and-hold strategies from an investor's portfolio. But what if portfolio construction started with the view that today a portfolio should be nimble and actively managed so that it can quickly respond to, and take advantage of, current opportunities in the marketplace rather than slog through the ups and downs hoping to end with an up? I think the former portfolio would produce better risk-adjusted returns.

Active trading strategies generally outperform in volatile markets. Not only have the markets experienced unprecedented volatility during the past two years, but it also appears they may have fundamentally changed from those of a decade ago when volatility was relatively low and thus buy and hold made more sense.

Those who can achieve success in the new markets are active and professional - they trade for a living and enter and exit positions quickly, based on traditional and, often, non-traditional analyses. They now account for approximately 60 per cent of all trading volume.

However, unless you have been trained to become a professional trader yourself, or are willing to invest in a short-term trading hedge fund, as an investor you have virtually no way to gain access or adequate portfolio exposure to what has become a worthwhile investment strategy.

It therefore behoves Wall Street to roll up its sleeves and seek to fill this void by creating a new financial instrument. What we need is a synthetic product that would replicate the intraday exposure of a Wall Street proprietory trading desk, thereby giving investors the opportunity to gain the return profile of an active trader, while maintaining the long time horizon that a position in a mutual fund would offer.

This would give investors an equity product that would not correlate with the market, but would capture the market's daily moves through an active trading strategy. While there is understandably some scepticism around the inner workings of Wall Street products, the creation of a new product, coupled with the regulatory scrutiny the new US administration is promising, just may provide investors with a fighting chance.

Of course, there have been periods over the past century during which decades of buy-and- hold success can be strung together. But the world has experienced fundamental change. It is clear the time has come to replace or at least supplement a buy-and-hold strategy with an active trading strategy. The notion that an active trading strategy is hazardous to one's wealth should be dispelled.

The writer is president of New York-based Schonfeld Group, which runs proprietary trading, investments and asset management businesses .