Our public markets are remarkable institutions, and whenever a passive investor can gain access to seasoned businesspeople through public markets, they will almost always do better than they could on their own.

Investment Method

The Best of Both Worlds


Just as the different types of financial advisors is confusing, so too the different investment methods have become confusing for customers to sort and understand. There are many different approaches to money management, all claiming to be the best. In fact, confusion itself is now used as a competitive strategy in the investment business. By casting doubt on other methods, a competitor hopes to encourage a customer to move their assets.

confusion.jpgThis state of the market – confusion - almost requires that clients become students of investment theory, when all they wanted was sound service and advice. What I say in this chapter is of course my own contribution to the confusion, my own attempt to discuss what I think is best and why. Still, I believe that my perspective is slightly different. I originally came to investments as a customer, and spent several years on the “customer side,” trying different firms and approaches. As I went through each firm, and became dissatisfied in each place, I gradually formed my own opinion about how best to manage investments.

So here’s what I think.

Past Is Not Future

Many firms will throw reams and reams of quantitative information bound up in booklets at you. Often these books will contain calculated return and risk measurements showing you exactly how your portfolio should look with exactly which allocations to which asset classes and so forth. The truth is that these calculations are based upon past performance – that’s why they always put those disclaimers on the page that state: “Past performance is no guarantee of future results.” While we can certainly make some valid generalizations - stocks will probably outperform bonds over a long period, or holding international stocks helps diversify - I believe that no one knows exactly how to allocate a portfolio based upon past performance. Instead, I prefer to be roughly right and use past performance as a guideline, and not a Bible.

Most Managers Don't Beat the Benchmark; A Few Do

Other firms will promise you that they have what it takes to beat markets by picking stocks, that they have the research and smart brains and methods that will make you more money. The trouble is that it is nyse.jpgextraordinarily hard for almost anyone to beat market indexes over a long term (say five years or more). And yet hope springs eternal in both managers and their clients. The truth is that most managers will not outperform market indexes over the long haul, for a variety of reasons: higher (sometimes obscenely higher) fees, higher taxes from turnover, manager turnover, and just plain mistakes. Nevertheless, there are some managers that practice value investing who show some superior ability to make investments that outpace market indexes over the long term. However – you can probably count them on two hands, and – please don’t take offense - neither you nor your current manager are likely to be one of them.

Technical Analysis and Market Timing Don't Work

Some managers will tell you they have the ability to know which direction the overall stock market is going to go and when. This is called market timing. Studies show that they do not know which way the market is going to go or when, and that such advice is a poor basis for investing. And yet, there are many investors who place their trust in such misguided managers. Other managers will tell you that they can discern which way a stock or the market is going by looking at some charts, so-called technical analysis. Again, rigorous studies show that this is mostly nonsense.

Active and Passive

My view of the best investment method is relatively simple: most professional managers who pick stocks (so-called “active managers”) will not beat their appropriate benchmarks over time. So it makes sense to invest at least half of your money in the benchmarks/indexes themselves in the form of low cost index funds. And then, if you want, place the other half with the best (and most reasonable) managers to compete against those benchmarks. That’s it. Many advisors get bogged down in the argument about “active versus passive” and “stock picking versus index funds.” Both methods have merit, and therefore both methods can and often should be strategically employed. The trick, however, is to know which indexes are sound and which managers are capable.

Diversification.  Everyone Says It.  Few Do It.  I Will.

tokyo.jpgAlmost everyone in the investment business says they believe in diversification, but few actually do it. Many portfolios that I inherit are not well diversified. Often that is because a client, understandably, has not known how to implement it. But just as often (and more surprisingly) I see portfolios managed by well-known professionals containing allocations to US large cap equities (or some other area in which they specialize) - and not much more. I believe that many pariscac.jpgprofessional managers fancy themselves to be capable stock pickers, and their main effort goes into constructing portfolios based on their specialty. In achieving this, they have neither energy, imagination, nor client capital remaining for domestic mid and small caps; domestic and global real estate; domestic government, inflation protected, and corporate debt; international equities; emerging market equities; international debt; commodities; and special vehicles. When I promise you diversification I mean it, and you will have it. Under my management, you will participate in the major markets of the entire world and own a risk adjusted and tax managed share in their performance.

Hedge Funds and Private Equity are not Different Asset Classes

You may have noticed that I did not list hedge funds or private equity funds - currently all the rage - in the previous paragraph. That is because, contrary to what the investment business wants you to believe, neither constitutes its own asset class, the main qualification for being included in a diversified portfolio. Both of these fund types invest in the same asset classes that are available to everyone through public markets. Hedge funds, in fact, invest almost exclusively in publicly traded assets. And most private equity funds (except venture capital funds) often invest in public companies by purchasing all of a company’s shares and taking it private. All things considered, I would prefer to be the owner of a hedge or private equity fund than an investor in one. That is because the fees charged by these funds are exorbitant and their restrictions on client access to capital are significant. These funds represent different strategies, not asset classes, especially in their use of leverage (debt) and short sales. And it may in fact be that your portfolio can benefit from managers who short securities and leverage their bets, and I am not totally averse to these types of funds or strategies. But under my management, we will try to be clear about why we are deciding to make someone else rich with your money rather than the other way around.

If You Don't Love Doing It, Proxy It

Often people will ask me about becoming personally involved with a certain class of investment: starting their own company, buying a piece of real estate, drilling an oil well, or purchasing art are examples. In my experience, unless a person truly enjoys and either has or can effectively develop expertise in a field, it is far easier to gain investment exposure to such assets through alternative means, a proxy. For example, real estate investments can be made through public real estate investment trusts, and participation in an art “boom” can be gained through the shares of publicly traded auction houses. And because such investments are public, they are highly liquid and can be sold for cash whenever the stock exchange is open. Our public markets are remarkable institutions, and whenever a passive investor can gain access to seasoned businesspeople through public markets, they will almost always do better than they could on their own.

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