Success Requires Flexibility

Yesterday I stumbled across a series of articles that I think all tie into the need for flexibility in portfolio construction and cycle navigation along with the need to understand that all aspects of this business evolve. Sometimes evolution is slow but sometimes it is rapid and awareness of this can be a crucial determinant of success in pursuing the ultimate goal; having enough money when you need it.

The first article comes from the CFA Institute and questions the college endowment model like the ones made famous at Harvard and Yale. The article pointed out 1990 to 2007 as being unique because the equity market went up nine fold. In that time there was a proliferation of "new" investment vehicles like hedge funds, sovereign wealth funds and as already mentioned we learned a lot about the endowment models of Yale and Harvard.

The article posits the need for more of a top down approach going forward with less focus on the "investment silo" that has made Harvard and Yale so successful. The idea being that a nine fold rise lifted a lot of other boats and that if a nine fold rise will not occur again in such a short time then the approach needs to change to, in the author's view, more top down which is a nice bit of confirmation bias to what I have been doing.

There was an interesting bit about diversification in this article that on the one hand it works except when you need it like in 2008. On the other hand all it really does is make sure you are not too concentrated in the worst performing asset class so in that context it worked in 2008. You can draw whatever you want from that but I thought it was an interesting framing of the debate.

In reading these types of analyses one thing that always seems to be missing is the acknowledgment that cash can be an asset class and a tactical tool. If you somehow knew that stocks would drop 50% and could only choose between owning stocks and cash yielding zero wouldn't you switch to cash? So while in the real world we cannot know that the market will cut in half we can understand when conditions are more favorable for equities and when they are less favorable and act accordingly. While pensions and endowments may have constrictions on how much cash they can hold you as an individual or as an RIA have no such constrictions which is an advantage you have; you can use cash as a tactical tool.

Cash didn't drop 50% from October 2007 to March 2009.

Also is this from All About Alpha asking, perhaps half jokingly, if a meaningful allocation to gold could have mitigated the return issues that so many pensions have. AAA talks about the small slice that gold has in the S&P GSCI Index that many pensions apparently benchmark to for their commodity allocations. The allocation to a broad commodity index seeks a diversification from equities but a broad index still is sensitive to economic cyclicality but the reasons for owning gold are different. In a way owning gold is simpler because it represents the fear trade. In a way it is more complicated because the emotions behind fear are complicated. Whatever your take between the two gold by itself is still different than an index dominated by crude oil.

The final article that I think is related is about ETFs being the next bubble. The actual article is so illogical that I am not going to address it other than to say not every ETF will be right for every investor and some ETFs will not be right for the vast majority of investors but there is a negative sentiment toward the product that exists and this article is just another example.

You as an individual or RIA are not constrained by mandates devised by bureaucrats that must take in political considerations. Assuming you are willing to spend the time you can go anywhere in any proportion you want. While 15% in gold is way too much for my liking and no endowment or pension would get anywhere close to 15% you can (just an example and allocation like that would be extremely volatile). The AAA article mentions part of the problem for pensions was the so called lost decade of the 2000s for large caps stocks in the US and the Western European markets along with Japan that dominate most foreign benchmarks.

Again, you have the flexibility to avoid those segments. Obviously this is what I've been doing and what I have been writing about for a very long time but the notion of your having more flexibility is a different way to frame this and I think promotes how important it is toward the ultimate goal of having enough money when you need it. Owning Brazil for example, was far less important in the 1990s than it was in the 2000s. The necessary exposures changed dramatically from the one decade to the next which is exactly what I have in mind in talking about evolution.

This flexibility and evolution can include ETFs or not but for most of us, at least a little ETF exposure will probably make sense. Certainly it does for the way we try to help our firm's clients.