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Investing hot shots didn’t get that way through timing

The forecast calls for a market correction. The hard part is figuring out what to do about it.

On Tuesday, billionaire hedge fund manager Leon Cooperman joined a long list of money mavens who foresee trouble for U.S. stocks. Mr. Cooperman told the CNBC Institutional Investor Delivering Alpha Conference in New York that a market correction could start "very soon."

Many others have expressed similar concerns in recent months, including Paul Tudor Jones, Scott Minerd, Philip Yang, Larry Fink, Jeffrey Gundlach, Howard Marks and fund companies Pacific Investment Management Co. and T. Rowe Price Group Inc.

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Some have even suggested that investors attempt to dodge the next correction. Mr.Gundlach has said that investors should move "toward the exits," and Pimco urged investors to move their money to less risky assets.

Two legendary investors are doing just that. Bloomberg News reported last week that Seth Klarman's Baupost Group is "holding 42 per cent of its assets in cash."

Warren Buffett is playing defence, too. Berkshire Hathaway Inc. is holding 15 per cent of its assets in cash -- a stockpile of roughly $100-billion. The last time Mr. Buffett held that much of Berkshire's assets in cash was in the years leading up to the financial crisis from 2003 to 2007.

All of this collides with the advice typically given to investors. Buy and hold for the long term, they're told. Ignore the level of the stock market and never attempt to time it. Meanwhile, the industry's brightest lights are doing just the opposite.

So which is it: Should investors attempt to time the market or not?

One obvious consideration is that few investors have Mr. Klarman's or Mr. Buffett's investment acumen. In fact, most investors are horrible at market timing. By my count, investors in actively managed U.S. stock funds captured just 71 per cent of their funds' returns over the last 10 years through July because of ill-timed moves in and out of those funds. By comparison, investors in U.S. stock index mutual funds captured on average 96 percent of their funds' returns because they were more likely to buy and hold.

A second consideration is that the reward for successfully timing the market over long periods is more modest than investors realize. I attempted to quantify that payoff in a column last year by simulating a market-timing strategy that uses the cyclically adjusted price-to-earnings, or CAPE, ratio for U.S. stocks to allocate between stocks and bonds. The strategy favors five-year U.S. Treasuries when the CAPE is high and the S&P 500 when the CAPE is low, but always has a sizable exposure to each.

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My market-timing strategy beat buy-and-hold 72 per cent of the time over rolling 10-year periods since 1926 by an average of 0.3 percent annually.

Which leads me to believe that little if any of Mr. Klarman's or Mr. Buffett's success stems from market timing. Baupost's performance isn't publicly available. But using Berkshire's historical cash allocations, I devised a simple model to see whether Buffett's market timing likely helped or hurt his performance.

Berkshire's allocation to cash as a percentage of total assets averaged 9 per cent from 1987 to 2016 -- the earliest year for which numbers are available electronically. The high was 23 per cent in 2004 and the low was 1.3 per cent in 1994.

I assume that Berkshire's return on cash approximated the return on one-month Treasury bills and that the return on its noncash assets approximated that of the S&P 500. (Granting, of course, that Mr. Buffett has beaten the market.) I then compared the return on Berkshire's actual cash and noncash allocations with a static 9 percent allocation to cash.

It turns out that Mr. Buffett's market timing has likely paid off, but only modestly. Mr. Buffett's allocations returned 9.6 per cent annually during the period, including dividends, whereas the static allocation returned 9.5 per cent annually.

Investors who can stick to a measured market-timing strategy may be rewarded. But the next time you hear a billionaire investor calling the next correction, remember that they most likely didn't get rich by timing the market.

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Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

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