Investment Philosophy

Risk-managed investing for peace of mind

Status quo investing is broken.

With few exceptions, the financial community practices “Buy And Hold” investing. In short, Buy And Hold investing is based on the belief that while the market will go up and down in the short term, over the long term — five years or more — it will rise at a relatively predictable rate. So in periods of economic upheaval, investors are told to be patient and wait out the storm, and not “panic” and rearrange their portfolios.

This confidence in an ever-rising market forms the foundation of the mainstream approach to portfolio construction. Investors are taught to decide how much risk they’re willing to take — greater risk offers higher potential returns, but also an increased chance of losing your money if things go wrong. Once investors settle on the level of risk they’re comfortable with and what time frame they have, they’ll then know how best to divide their investments. For example, if they need their money in four years and would rather have lower but more reliable returns, they might go with a conservative portfolio made up of 70% bonds and only 30% stocks.

According to Buy And Hold investing, each time frame and level of risk has its own ideal asset ratio. And because Buy And Holders believe the market grows at reliable, historical rates, investors can depend on receiving the returns they were promised when they first created their portfolios.

Unfortunately, things haven’t worked out that way.

If you had entrusted your nest egg to the S&P 500 on January 1, 2000, expecting a historical annual return of 11%, you’d be in for an unhappy surprise: By December 31, 2010, your investment would have grown a paltry 4.25% in total returns, 0.38% per annum, which includes reinvested dividends. Once you calculate in 3% inflation per annum, you would have actually lost ground. That’s no way to save for the future.

Wall Street to the rescue! (Well, not really.)

Wall Street has known about the problems with Buy And Hold investing for many years. So in response, they developed a new type of investment style that would “hedge” the results of those portfolios that depended on the markets delivering expected historical returns. That’s how hedge funds and “alternative investments” came to be.

Hedge funds, as the name implies, are designed to hedge the performance of a traditional portfolio by using strategies that are not dependent on the markets. Alternative investments, like private equity pools and managed future funds, are intended to do the same thing. It’s not uncommon for hedge funds and alternative investments to make up 20%-30% of today’s most sophisticated portfolios.

Unfortunately, both approaches suffer from a serious weakness: They rely on managers to execute those strategies. Modern behavioral finance tells us that money managers are subject to biases and heuristics that can lead to poor decision making. Being human, they’re vulnerable to the crowd mentality and can succumb to panic buying and selling. Not only that, but those strategies tend to be inconsistent in their effectiveness — in other words, “they work until they don’t work.” Managers who dogmatically follow one approach can make large bets with investors’ money that result in catastrophic, unexpected losses. If you’ve followed the financial news over the past ten years, you’ve seen plenty examples.

Our solution: Balancing investment art and science.

In our view, neither the traditional Buy And Hold approach nor the risky strategies of hedge funds and alternative investments are ideal. What is needed is a strategy that utilizes the best ideas of both. We believe we’ve achieved that. In 2002, our investment team combined the portfolio diversification of traditional investing with active portfolio management to create our proprietary investment strategy.

While status quo advisors agree that portfolios should be diversified — it’s the investment equivalent of not putting all your eggs in one basket — they reject the idea that portfolios should also be actively managed. Because of their near-religious belief that markets will eventually deliver the returns that they have in the past, they tell their clients to “be patient” and wait out any market turmoil (even when it lasts over ten years).

We disagree. Instead of sitting on our hands and hoping the market will eventually deliver the returns our clients need, we respond to changing economic and market conditions by modifying our portfolios asset allocations accordingly — first, to minimize any risk to their assets, and second, to take advantage of opportunities to increase their returns. And unlike other firms, our Investment Team isn’t limited to specific asset classes — they’re free to invest in whatever offers the best value, so long as they stick to the risk levels set by our individual clients. This comes out of our fundamental belief that asset classes will earn the best returns if we buy them at prices that represent good value.

If our investment philosophy resonates with your own personal approach, please give us a call at (305) 274-1600 or contact us online.