Why I'm An Active Portfolio Manager

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  • on December 23rd, 2009

I get it, I really do. No one can predict the market, so why endure the fees and time associated with trying to “beat” the market?  There’s something to be said for keeping costs down, especially when you add in commissions.  The problem is with the assumptions going into the “pot of gold if you buy and hold” equation and Modern Portfolio Theory…brings to mind the old saying “Garbage In, Garbage Out”.

I don’t have a clue as to what will happen in the next 30 years, but let’s assume(dream?) that we will continue to see the largest ever migration of people entering the capitalist system and engaging in free trade across the globe.  Let’s also assume that valuations of paper assets can expand from moderate(high?) levels the way they did from cheap levels.  Great, as David Tepper says, “Trees grow“…now what?  Continued assumptions for financial assets of 10-12% long-term equity returns?  I’m sorry, but an asset that suffers 50% drawdowns as equities did in the 1930s, 1970s, and 2000s had better return a hell of a lot higher than 12% for me to hop on that ride.  Hoping that the next 50% drop will wait until we’re dead isn’t a solution.

What assumptions can we make? Let’s start with these:

1) Global economies will oscillate above and below the 100 year trend of 6% growth discussed by John Hussman

2) People will pay WAY too much after years of good returns, and sell WAY too cheap after years of bad returns(see Ben Graham, Daniel Kahneman, Jeremy Grantham, Robert Shiller,etc.)

3) #1 is a guess, #2 is a certainty

I therefore take an active role in managing risk for myself and my clients.  I won’t build a portfolio based on scenarios that occur 95% of the time.  It sounds comforting, but my job is to have an imagination with the 5% for which they are not planning.  I can’t guess the events, but I know what 2 scenarios can devastate a portfolio:

1) Asset deflation

2) Cost of living inflation

That is my job as I see it.  Most can figure out the popular paths on their own…what I can add are the layers of catastrophe insurance in case the future doesn’t cooperate with our plans.  Using a fixed income core, some beta when healthy, and a little alpha when offered, we seek to cut the drawdowns from 50% to below 15%, giving investors a much better chance of staying on board.  If I can also act in ways that protect their purchasing power in the event of hyperinflation, I’ve done my job.  We won’t see 20% annual returns, but we also won’t see double-digit losses.

Anything less is unacceptable for my money, and unacceptable for a client.  A non-professional investor should be free to shovel hard-earned savings into their nest egg, and leave it to an advisor to build a portfolio robust enough to handle the next 100 year flood.  Considering these floods show up every few years, it’s crazy to think we won’t see another one before a client needs his/her money.  Just don’t ask me what it will be because my guess is as good as the next guy’s…fun for discussion but ultimately worthless.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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