One of the tenets of good practice management is to stay current with the technical aspects of the business in order to meet your service commitments.

For advisors involved in the asset-management side of the business, that means maintaining and expanding your competency in investment strategy. James O’Shaughnessy’s Predicting the Markets of Tomorrow: A contrarian investment strategy for the next 20 years may help you meet that need.

You might recognize the author. O’Shaughnessy is a highly regarded mutual fund portfolio manager (he is a subadvisor for RBC O’Shaughnessy funds) and the author of the best-selling books How to Retire Rich and What Works on Wall Street.

Either way, he has credibility and warrants attention.

Predicting the Markets of Tomorrow builds on concepts presented in his other works — in particular, the idea of asset allocation as an intelligent investment strategy (a topic dear to my heart).

What makes this book compelling is it validates the notion that a broadly and properly diversified portfolio can achieve higher returns with less risk over the long term than one that attempts to identify and focus on the current best-performing asset class. That concept gets lost whenever one market sector dramatically outperforms all others and investors flagellate themselves — or their advisors — for not having more, or all, of their investments tied to that rocket.

This happened with tulip bulbs in the 17th century, radio stocks in the 1920s, aluminum stocks in the 1950s, computer stocks in the 1980s, technology stocks in the early 1990s and was most recently capped by the dot-com bubble that burst in March 2000.

O’Shaughnessy’s premise is that, throughout these market cycles, the period of time that appears to have the most statistical consistency and during which market sectors tend to regress most toward their mean performance is 20 years. Therefore, 20 years is the best time frame from which to predict most accurately what comes next. It also coincides with the investment time horizon of most investors, who do not, typically, begin to amass significant portfolios until middle age.

From that fundamental belief, O’Shaughnessy suggests where opportunities for the next couple of decades lie. His preferred portfolio is:

> 50% small-cap;

> 35% large-cap value; and

> 15% large-cap growth.

Historically, over the past 80-plus years, the long-term average real return (adjusted for inflation) of this mix has been 9.11%, with a standard deviation of 28.90%. For rolling 20-year periods, the lowest real return has been 3.26%, the highest has been 16.65% and the average return for all 20-year periods was 10.15%.

Over the next 20 years, based on O’Shaughnessy’s analysis, he projects lower real returns — a minimum of 5.99% to a maximum of 7.99% for this allocation.

It is possible to implement this asset mix via individual stocks, mutual funds or exchange-traded funds. O’Shaughnessy maintains that the results can be improved by applying the following stock selection strategies:

> 10% tiny titan micro-caps. These are companies with market capitalizations between US$25 million and US$250 million, a price/

sales ratio of less than 1.0 and high price appreciation.

> 15% cheap on-the-mend small-cap growth. These are companies with market capitalizations between US$250 million and US$2 billion, a price/sales ratio of less than 1.5 and both earnings and price growth.

> 25% dogs of the dow. These are the 10 stocks in the Dow Jones industrial average that have the highest dividend yields.

> 25% market leaders with low price/cash flow. These are large-cap value stocks with the lowest price/cash flow ratios.

> 25% market leaders. Large-cap growth stocks with low price/

sales ratios and growing earnings and prices.

In each instance, individual securities have to “requalify” each year to be included, and the portfolio is rebalanced annually to maintain the asset allocation.

The book also contains a useful summary of the core concepts of behavioural finance to help explain investors’ irrational thinking.

O’Shaughnessy’s research is based on U.S. market data. But the high long-term correlation between Canadian and U.S. markets makes his strategies worthy of consideration.

At first glance, the book appears to be an intimidating compendium of statistics and graphs. But the data presentation repeats itself so you learn to compare the numbers from one asset class to another. If you are patient, you’ll be rewarded. IE