An investment manager named Mariusz Skoniecny wrote a post for Seeking Alpha that was very skeptical about the practice of diversification and the motivations behind it. Throughout the post portfolios with 100 holdings drew his ire but I did not glean what number he thinks is right.
He believes that diversification hides incompetence and does not give an opportunity for meaningful outperformance. Although I do believe in diversification I cannot say Skoniecny's arguments are off base. He talks a lot about reps at brokerage firms whose job it is to sell not analyze stocks which is a point I have made before. He notes that by diversifying you avoid the consequence that a blown up stock can have on a portfolio which I view as a good thing.
The building block here is that a proper savings rate, suitable asset allocation and a normal equity market return should give people a decent shot at having enough money for when they retire. A realistic understanding of one's means doesn't hurt either.
It is this idea that is a foundation for how I navigate cycles. I try to go along for the ride during up-a-lot, up-a-little and down-a-little and try to avoid the full brunt of down-a-lot by taking defensive action when the SPX is below its 200 DMA as it is now. To repeat from above this should give people a decent chance of having enough money when they need it, again assuming reasonable spending habits.
A variable that we are collectively trying to assess is "normal" equity returns. The last decade has not been normal. Actually maybe it has been normal. I would not say I am totally on board with the 18 year cycle concept but there is something to it. Stocks did poorly for a long time in the Great Depression into the 1940s, did very well until about 1968, did badly until the 1982, did great until 2000 and then the last ten years. If there is any meat on this bone then we would be in the neighborhood of halfway through.
That there could be eight more years of sideways trade probably tells you one of two things. On the positive side (the way I choose to look at it) you can commit to yourself to save like hell so that when equity markets (global or domestic) start some sort of up cycle you will have a lot of powder that you can deploy. The negative side is that a do nothing market means your portfolio will probably not do anything.
I am more comfortable articulating this as saying long round trips to nowhere have happened before and then they end and are followed by an up market. We have no control over when this will happen so I prefer not to worry about it and just go along for the ride during up a lot, up a little and down a little and try to avoid the full brunt of down a lot by taking defensive action when the SPX is below its 200 DMA as it is now (repeated for emphasis) because this is more in my control.
If going along for the ride combined with proper asset allocation and the rest is enough to get the job done for many people then adding value can come in the form of simple enhancement of returns (aka smoothing out the ride) and not necessarily making a killing and taking the risks needed to make a killing.
It is not that a 12 stock portfolio (or however many names that Skoniecny owns) is wrong, the correct way to frame it is what is right for you. For me the ideal number is 35-40 holdings. For some folks it will be more and some it will be less. And yes I personally am very motivated to try to avoid portfolio action that causes clients to react emotionally.
Now something of a personal note. A friend who is my age, whom I used to work with, had a heart attack on Saturday. He is ok, he said his prognosis is good. I know nothing about his exercise or dietary habits but he did say his mother died of a heart attack.
This is a good wake up call about priorities. Health comes before money. I don't think too many people disagree with that but it is worth saying. Not going to the gym is the easiest thing in the world. Just like saving properly and investing smartly doesn't guarantee a successful investment plan going to the gym doesn't guarantee successful aging but it gives you a very good chance.
As far as diet goes, the best starting point IMO is to never drink soda.
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17 comments:
Also don't smoke and wear a seatbelt. Then cut out the high fat and sugar. Then exercise. In order of importance.
Dr. L
my long standing joke about smoking:
I read the literature and liked what I saw.
That there could be eight more years of sideways trade probably tells you one of two things. On the positive side (the way I choose to look at it) you can commit to yourself to save like hell so that when equity markets (global or domestic) start some sort of up cycle you will have a lot of powder that you can deploy. *The negative side is that a do nothing market means your portfolio will probably not do anything.
I am more comfortable articulating this as saying long round trips to nowhere* have happened before and then they end and are followed by an up market. We have no control over when this will happen so I prefer not to worry about it and just go along for the ride during up a lot, up a little and down a little and try to avoid the full brunt of down a lot
……………….
If going along for the ride combined with proper asset allocation and the rest is enough to get the job done for many people then adding value can come in the form of simple enhancement of returns (aka smoothing out the ride) and not necessarily making a killing and taking the risks needed to make a killing.
Not sure how you are defining “making a killing” so let me posit the following scenarios for say the next 5-10 years. Scenario 1 would be annualized returns from 0 to maybe 3 which I would consider unacceptable irrespective of what the overall market does (even if the market is 0 and you get 3% outperformance). Scenario 2 is maybe 4-7 which I would consider decent. Scenario 3 would be 8-10ish which would be good and finally 4 would be 10%+ which would be “making a killing”.
Let’s further posit that the S&P 500 does in fact return 0-2% annualized from today’s level through Dec 31, 2019 and put that in the context of diversification and going along for the ride.
Here is the question I wrestle with as someone else who is doing this professionally and charging for the investment management provided. How do I justify to a client and to myself in the mirror charging 1% annually for delivering say 2-4% returns over a 5+ year time period even if the market is completely flat. Does that fall into the category of “just not good enough” and it doesn’t matter if the market was zero?
This line of thinking is what leads me to the thought that “going along for the ride” just isn’t good enough yet I don’t want to take aggressive crazy bets. This is why I have been so focused on assessing whether it is more likely this is a bull market correction or start of a bear. I want to get out of the way of a bear and ride through the bull correction. Otherwise, one might find myself on a long ride to nowhere.
I have to think there is a optimal balance between excessive diversification that basically has one copying a potentially zero market return and not enough diversification that opens up big risks of losses.
If it matters, my overall returns since 2004 is north of 25% cumulative which is nice compared to the S&P 500 since 2004 but for me personally falls into the category of “not good enough”. I’d be disappointed if I did 25% or less over the next 5 years, but I don’t’ think the S&P 500 will provide anything near 25% over the next 5 years.
making a killing is vague of course but one example might be up 30% in a year that the market is flat. Getting that type of number in that circumstance would require a fair bit of risk taking for most people.
Maybe I am misreading your comment but I take an implication about uniformity of return year by year which of course is not how the market works.
From where I sit I view the task as first giving clients the best chance I can to have enough when they need it. Next I hope to be able to do that with as smooth a ride as possible.
I have said before you can only take what the market gives which I mean as you can't be up 30% in a flat world (unless you do take a lot of risk). While that may not be true in a absolute terms it is true for most people. I am not willing to bet client money as to whether I could be up 30% in a flat world. Candidly that would not suit my personality.
Part of what an advisor should do, IMO, is prevent the client from panicking, knowing when conditions are most favorable for a good stock market result and when conditions are not favorable for a good stock market result.
Someone who can deliver this should give their client a very good result over the enitre cycle both in terms of nominal return and risk adjusted return.
Of course this is a belief, other people have their own beliefs.
I buckle the seat belt behind me because it is iritating,last year took up a one fine cigar per day ritual and enjoy lots of dividend and retirement income and growth - more than I need. I exercise by briskly walking to the mailbox (and back) and receive an upper body regimen opening envelopes and endorsing the daily stack of checks enclosed, while nodding my head in approval.
I am hopeful to live until age 112,killed by a mob of jealous husbands.
@Mike just my opinion: if your clients hired you to run an equity portfolio benchmarked to the SPX then you should stay the course with most of your policy portfolio.
On the other hand if your clients hired you to provide absolute returns over inflation then I personally would radically de-weight US equity core holdings to less than say 15% of the portfolio - maybe consider zero core weight. Then go where the bull markets are: gold, long bonds, commodities, low-debt individual countries, CHFEUR. Success is not guaranteed of course but you will be off of the trail o' tears to 2020 ;-)
New topic: I changed my family's diet after reading this book about heart disease: "Prevent and Reverse Heart Disease" http://www.amazon.com/Prevent-Reverse-Disease-Caldwell-Esselstyn/dp/1583332723
making a killing is vague of course but one example might be up 30% in a year that the market is flat. Getting that type of number in that circumstance would require a fair bit of risk taking for most people.
OK, got ya, and absolutely agree. Frankly, if I was up 30% in a flat year I’d hope someone would be savvy enough to call me out and ask exactly how it was achieved. A result like that should be a potential red flag of excessive risk being taken
Maybe I am misreading your comment but I take an implication about uniformity of return year by year which of course is not how the market works.
Yes, I think you are misreading me. Really all I’m saying is the more you look like the market in terms of sector allocations, more stock positions at smaller percentages the more your return will be similar to the overall market. The more willing you are to deviate (like say 10 stocks at 10% each) the more you will deviate from the market return.
From where I sit I view the task as first giving clients the best chance I can to have enough when they need it. Next I hope to be able to do that with as smooth a ride as possible.
I’m with you, but let me play devil’s advocate because these are the types of questions someone playing a little hardball might ask. One question/point might be, no you are not necessarily just providing me with “enough when I need it”. I can do that on my own by saving 25-30% of my income each year and sticking it in bank CDs. I don’t need to pay you 1%+ to do that. On some level, I am paying you to achieve some minimum level of returns over a long enough time frame and I absolutely do not care what the market does over that time frame. Market down 10% over 5years. I don’t care, your job is to find somewhere, somehow to generate reasonable positive returns.
I have said before you can only take what the market gives which I mean as you can't be up 30% in a flat world (unless you do take a lot of risk). While that may not be true in a absolute terms it is true for most people. I am not willing to bet client money as to whether I could be up 30% in a flat world. Candidly that would not suit my personality.
Again, agreed about the up 30% in a ZERO world. That is the specific reason I framed my scenarios as annualized returns over 5-10 years, and not a single year. Theoretically, up 6% annually over 7 years versus market up 2% annually over 7 years should be possible without taking a lot of risk, but is very difficult.
Part of what an advisor should do, IMO, is prevent the client from panicking, knowing when conditions are most favorable for a good stock market result and when conditions are not favorable for a good stock market
Absolutely agree
continued
I’ll rephrase my basic question. What is the absolute minimum return that needs to be provided over say a 5+ year time frame to basically “earn one’s keep” irrespective of overall market performance, and the other issue you mention like preventing panicking, providing good perspective, etc.
I think it is just difficult because we are probably in a low-return world for many years. Equity returns are likely to be mediocre at best, even emerging. Interest rates are low. People doing this in the 80s and 90s had an easy time just coasting on two huge secular bulls, equity and bond, and could probably spend more time playing gold then doing research and still crank out great returns. I think this post is symptomatic of how many professionals feel:
http://runningofthebulls.typepad.com/toros_running_of_the_bull/2010/06/gold-sentiment-not-high.html
I have had several conversations with investment professionals over the past few days regarding gold. *****I have been asked by people in the investment business what they should do with their money, given the low prospective returns for most asset classes.***** I asked them if they are invested in the only bull market going, gold. The response? Skepticism. All but one said "No." They don't understand it, they tell me. I tell them that it is much easier to make money in a bull market than in a bear market, but no dice. They have no interest.
I’m sincerely interested in your take on that basic question above if you care to share, but maybe at this point any further back and forth is best taken out of the comments section of this post and moved to another forum. You’ve got my Gmail address and we are both on chat
"playing gold"
LOL, Freudian slip there
I meant playing golf
One that this blog does is to explain how I come at doing the task. I do what i do. Other advisors, for economy of words, are far more passive than I am and some are far more active than I am.
Earning one's keep is a relative concept. If an advisors lays out ahead of time what the goal and then they deliver on that stated objective how can one say they did not earn their keep?
The question becomes whether what an advisor does is right for everyone and of course the answer is no. Recently we were contacted by a fairly sophisticated prospect who was interested in hiring us. We told him what we do, how we do it and why we do it that way (I believe we are good at articulating this). Based on what he was saying I knew it would be a bad match and even said so early on in the process and this was the conclusion that he ultimately drew as well--he wanted something far more active than what we do.
The notion of not communicating effectively is what causes clients to fire advisors (obviously I mean it is incumbent upon the advisor to make sure he is understood).
We look at the entire cycle and seek to add value over that time frame with the full understanding that we will not beat the market every year.
I wrote a post a while ago where i made up an example of an advisor lagging every up year in the cycle but very effectively taking defensive action at the right time thus beating the market by a wide margin for the cycle.
I would be thrilled with that result, tell that to people interested in hiring us and let them decide. Clearly this is not for everyone and so not everyone will hire us.
Roger,
Since you often reference "over the whole cycle" where do say "start of" or "end of" bull or bear and vice versa ?
interesting question, in the context of talking to a client it probably depends on when they hired us.
intuitively i would say probably bull then bear phase.
In reading his webpage, he purchases ten stocks that are undervalued by the market, with what he views as good one to three year prospects. If he's good/ lucky, he will hit one or two stocks that make up for his mistakes, like everyone else. He states that he will sell when a position is fair valued. What's your view on that, Roger?
Sam
as i said in my post i cant say his way is wrong but it is not right for me. an observation i have shared before is that often, the stock or two i would expect to be the top performer are in fact not the top performer.
10 stocks is too much live by the sword for me
I agree with the article that diversification is generally a protection against the managers' incompetence rather than a legitimate long term wealth creation strategy... can someone show me an investor who has done well over long periods (20 years plus) by holding 100 plus positions?
To my knowledge, long term wealth creation generally occurs via ones' own labors in the form of ownership of company stock or ones' investment prowess as displayed by holding a few well chosen securities over long periods of time... and being opportunistic when fat pitches come your way...
Has anyone looked at the Leucadia portfolio lately? I think they hold 4 or 5 stocks and a huge amount of the investment pool is in one stock... but they (as others like Buffett, Berkowitz etc) likely know that stock inside and out...
The slice and dice method which results in 1-2% in a wide variety of assets and securities is a great way of generating income for those in the investment industry, but I have not seen examples of anyone benefiting significantly from it over the long term... and of all the people I have known directly who have accumulated and preserved wealth over the long term, the most "diversified" portfolio contained 5 or 6 securities... most of them contained one or two securities held over multiple decades, with dividends reinvested and with shares accumulated during times of stress...
A. Non
it has been ages since I thought about him at all but did Peter Lynch hold a lot of stocks?
the narrow approach is certainly valid but I promise you that plenty of people succeed in the market with every type of strategy there is.
I would imagine more people fail with every strategy there is as well.
I recall 1200 at one point in the Magellan Fund when under his leadership.
Sam
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