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Ablin: Small caps not a safety net

Updated: May 3, 2013 12:14PM

In today's column: two topics that will affect your health and your wealth.

Everyone learned the importance of diversification after the 2001 tech bubble burst. The most common way to diversify is to start with a large company fund, typically a Standard & Poors' 500 stock index fund as your core position. Then, your remaining investments can be divided up into funds that concentrate on smaller companies, international stocks or specific market sectors.

It sounds easy, but Jack Ablin, chief investment officer at Harris Private Bank, a man responsible for $52 billion of managed wealth for individuals and families, sent out a warning last week. He looked at the protection investors would have received by diversifying around their core S&P 500 fund over the past 12 months. He tracked the performances of the Russell 2000 index of small capitalization stocks, the EAFE index of large capitalization foreign stocks and the EAFE emerging market stock index.

Ablin concluded that small cap stocks provided the worst protection: "Of the five worst trading days for the S&P 500, the Russell 2000 did the poorest job of diversification, plunging by more than the S&P in four of the five days observed, and on one occasion, June 5, 2006, by substantially more.

"The international markets did a better job of cushioning the blow. EAFE Developed fund outpaced the S&P 500 in four of the five days identified."

This study is worth noting because it goes against a common assumption, and because just hours after it arrived, I received another press release, one announcing that the Russell 2000 index hit an all-time high on April 17 at 831.71. Its key message: The Russell 2000 index is up 1.95 percent year to date, and 10.95 percent annualized over the past five years.Would Ablin want to take his words back?

No way, he says: "The only argument for buying the Russell 2000 now is that it's done well in the past. And I don't view that as a legitimate argument."

Ablin notes that seven years ago, the forward price/earnings ratio of the Russell 2000 was a full eight times below that of large cap stocks. But he points out that after the huge out-performance of small caps over large companies during the past six years (by about 80 percent), not only has that gap closed, but now small caps trade at a substantial premium to large cap stocks.

Even worse, Ablin said, "Profit expectations among small cap analysts are wildly optimistic relative to their large cap counterparts. We're wringing our hands with a 6-to-7 percent earnings growth expectations for the S&P 500 this year, while small cap analysts expect the Russell 2000 to deliver over 18 percent earnings growth in 2007!"

His final shot: "Essentially, all the Russell 2000 has going for it now is its history!"

I like an analyst who believes in hedging his investments, but not his opinions!

Health insurance hopeThere's a bit of hopeful news on the health insurance front for the millions of Americans who are over 50 and just waiting for Medicare to kick in. If you're planning to retire early, or if you lose your job at this age, it's difficult or extremely expensive to find health care coverage once your mandated COBRA extension of employee benefits runs out.

AARP has recognized this need and announced it will work with Aetna insurance to create a series of health insurance products designed to meet the needs of people age 50 to 64.

Dawn Sweeney, president of AARP Services Inc, a division of the organization that serves 38 million members over age 50, says the new policies should be launched in early 2008, and will be available to AARP members.

Sweeney says the problem -- or the opportunity -- is huge: "Our estimate is that there are more than 7 million people age 50-64 with no insurance at all, and many others are underinsured."

We'll be among the first to report on the policies when they become available. And that's The Savage Truth.

Terry Savage is a registered investment adviser. Check out Terry's answers to reader questions at, and click on Business.

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