Finally- My Portfolio Decision

[hrux]

First, my many thanks to Craig, MedTex and several of you on this forum and bogleheads for your invaluable insight on the PP.  As several of you know I had been contemplating the adoption of a PP strategy for a few years and have completed endless research on this, amongst other strategies.  The end result of my search has led me to turn my portfolio over to a true fiduciary advisor (CFA, CPA, CFP) that I have known for many years and have developed a comfort level with. 

I definitely think the PP has some merit. While I agree you can't know with certainty which asset class is going up, I do think you can reasobably weigh the risk/reward in some cases. For example, in 1999 the cap weighted P/E ratio for the S&P 500 was in the 30's, but the median P/E ratio was 12. Small cap and value appeared grossly undervalued, at least on a relative basis. A few large caps were driving the market up. If the economy kept growing (prosperity), it was a near certainty that this disparity had to correct. Investing in the entire market would not have allowed you to capture that advantage. It doesn't make this strategy invalid, but just an example of how a little thought could enhance it.

It also implies that there is an equal chance of each scenario occurring (at least somewhat equal). I don't think that's always the case, although I understand Harry Browne's premise in that there is no way to know in advance.

In the current environment I don't like the risk/reward for long-term bonds, but that is your deflation protection in the strategy. I agree that one would diminish the intergrity of the approach if you omit it. This is related to my comment about equal risk implied. One may think deflation is a possibility, but if the risks of investing in LT bonds greatly outwiegh the rewards does a 25% allocation make sense?

Overall, I like the concept of trying to protect in any environment. Even if you like the 4 equal parts PP strategy, I think it can be improved upon (as with my example above) with a little thought. I think the 4 equal parts HB PP type of strategy would be good for someone who wants a do-it-yourself, low maintenance strategy. However, as with any of these passive strategies, they may work over an extended period of time but you need the belief and fortitude to stick with it. There will be temptations to deviate.

One option (and one that Clive has mentioned) is that you may want to do something like this with a portion of the portfolio. Or you may want to use it as a baseline with some more active revisions (i.e. use the PP as your benchmark) and alter only if you have a good reason (e.g. 1999 S&P 500 example above, or underweight LT bonds currently). This acknowleges the validity of the philosphy, but allows you to incorporate your own beliefs or research. Sort of a core-satellite approach, with the PP as a core rather than the market.

However, in my situation I have aligned my portfolio with an advisor whom tries to incorporate these very same PP concepts into portfolios (accounting for the possibility of prosperity, inflation, deflation, recession) so again I very much believe in the need to invest for all market environments.

I would also like to note that my new advisor spent the better part of his career as a promoter of passive investing and disciple of Gene Fama and DFA. He believes that while DFA's research is certainly not without merit, he has come over the years to realize that the premise that markets are efficient is nonsense. Do you truly believe that investors make rational decisions based on the facts presented at all times? (if you ever sat in the chair of a financial advisor for a few weeks you would quickly change your mind). Indexing implies that prices should be adjusted so that the expected return of any stock should be the same. Do you believe that? Gene Fama doesn't believe it either which is why he recommnends a value tilt (the mysterious value premium he refers to). If markets are efficient than why does a value premium exist? Fama says he doesn't know why. I think I do. Becuase markets aren't efficient. Gene Fama claims that his appraoch will work over an investment lifetime. Are you willing to wait your investment lifetime to see if he's right? My advisor once asked Gene Fama how he can say markets are efficient if tech stocks were trading at multiples in the hundreds and companies without revenue or assets were valued higher than established companies in the same industry? He said that you could have shorted them any time 3 years prior to the crash on the assumption that they were overvalued, and you would have incurred large losses. My advisor told him that he meant that they could have just been sold. He wasn't referring to betting against them. If you had just sold them you would have been better off. Fama had no response for that.

Anyway, I am in agreement that markets are not efficient and the entire premise is flawed.  The question that investors need to ask themselves is do you want to target relative or absolute returns? If one is happy with relative returns and style box investing, perhaps you will be better off with a passive approach. I am no longer content with relative return victories. If the market is down 40% again at some point (a real possibility) I am not going to be satisfied that I am down 30%. Passive strategies are great in up markets because they produce positive returns. When I believe the wind is at our back and stocks and bonds are cheap again my advisor will be happy to re-adopt a passive approach. All evidence is that the wind in going to be in our face in the years ahead (at least on a secular basis), not at our back.  Further, style box, or relative return investing does not account for the notion that you could be entirely removed from an asset class, or invested in another. For example. let's say a large cap growth fund was down 5% when the market was down 2%. But at the same time, high yield bonds produced a return of +6%. Were you better off becuase you only lost 2% vs. 5%, or worse off because you missed out on +6%. A passive investor would argue that this is proof you can't beat the market. I would argue that you missed an opportunity.

One more thing I would like to point out is the definition of risk. Do you define risk in terms of volitility or loss of capital. I believe most individuals define risk as a loss of capital. They should also define it as a loss of purchasing power, but that is not easily comprehended by the typical investor (I know most of you understand it which has led you to the PP). Let's say one invested with a concentrated stock manager that modestly trailed the index after 10 years, but didn't lose money in any year while the market had some significant down years. Without knowing the future, would you be more comfortable knowing that your manager was managing your downside even if it cost you modest returns in the end? It's like buying a put option on your index portfolio.  Is it worth the cost of insurance to know your downside is limited? I would think most investors would say that the risk protection and peace of mind is worth the cost of a modest reduction in returns. And don't ever forget what happened in Japan (market down 75% after 20 years) or the US for 20 years after 1929. It can happen again and I am pretty sure Gene Fama will not be writing us a check to cover our losses if it does.

Sorry for my ramblings and hope they were somewhat clear. There is certainly more than one way to succeed as an investor. One's decisions become more significant each year that passes. The number gets bigger and there is one less year to accumulate assets. I think there are going to be some excellent opportunites with great risk/reward trade-offs in the years ahead and I want to protect my capital to take advantage if and when they do arise. The current market and economic imbalances are great. In economics, imbalances must be corrected. It can be gradual or abrupt (like 2008) but they must correct. I am not predicting a market crash, but the risks are elevated due to these imbalances. 60/40 portfolios will not hold up well in that environment (and imagine if it comes along with rising interest rates next time!).  I am confident that the PP will hold up relatively well however the following is what I will be investing in, although there will soon be a reduction to some of the Pimco funds due to their use of derivatives and better options.

Core Fixed Income
12%- FPA New Income (FPNIX)
6%- Franklin Adjustable Rate US Govt. (FAGZX)

Flexible Core
6%- Caldwell & Orkin
9%- Hussman Strategic Growth (HSGFX)
6.5%- FPA Crescent (FPACX)
6.0%-PIMCO Global Multi asset (PGAIX)
6.5%- Leuthold Core (LCORX)
5.0%- Pimco All Asset All authority (PAUIX)

Hedged Equity
6.0%- Gateway (GTEYX)

Market Neutral
5.0%-AQR Diversified Arbitrage (ADAIX)
5.0%- Driehaus Active Income
5.0%- AQR Managed Futures (AQMIX)
5.0%- Pimco Unconstrained (PFIUX)

Long Term Themes
2.0%- SSgA Emerging Markets. Recently reduced exposure to
emerging markets

Opportunistic
4.0%- S&P 500 Dividend Aristocrats ETF. Plan to increase
exposure soon
5.0%- Osterweis Strategic Income (OSTIX)
6.0%- Doubleline Total Return (DBLTX)

I sincerely wish you the best of luck in your investing initiatives and remember there is "more then one road to Dublin."
Take care,
Heather

PS- If anyone is interested I would be glad to refer you to my advisor if you PM me.

[MediumTex]

A few comments:

1. How have you had your money invested during the years of research regarding the best investment strategy for you?

2. Has your investment advisor provided a history of the returns that his own strategies have provided compared to whatever benchmark he is using?

3. Why so many funds?  It seems to me that almost any investing objective can be achieved with fewer than the 17 funds that your strategy is using.

4. How will you know when to move in or out of the proposed funds?  Are there rebalancing bands? 

5. What kind of fees are associated with the 17 funds in your strategy?

6. How will your advisor be paid for managing your account?  What kinds of revenue sharing agreements or other arrangements does he have with the funds you are going to invest in?

7. Did your investment advisor properly time the internet stock bubble?  Did he sell the high flyers before they crashed?

8. What would make you reconsider your strategy?  What scale of losses over what period of time would cause you to re-think the approach? 

9. It looks like you have no gold in your proposed portfolio.  Do you feel good about that?  Do you feel like your investment advisor has a strong grasp of gold?  I work with lots of institutional money managers and I have yet to meet one who I felt had a nuanced understanding of gold.

Good luck with whatever you decide.

[AdamA]

"When I believe the wind is at our back and stocks and bonds are cheap again my advisor will be happy to re-adopt a passive approach."

What makes you think your advisor (or anyone) can predict this?  And, if they can, why do you think an active manager can outperform passive returns?

Adam

[craigr]

Heather,

I'm glad you found something that works for you. I do not believe the markets are 100% efficient all the time, but they are mostly efficient most of the time. And that is unfortunately the best approach we have. It is not perfect, but a diversified passive approach has a very high chance of beating any actively managed strategy. I would also add that it is far cheaper to run a passive portfolio (less than 0.20% a year in most cases). Jack Bogle did a lot of research confirming that one of the primary ways to determine fund success ahead of time is to look at the expense ratio. The higher the costs, the worst the long term performance.

[hrux]

Hi hrux.

Good luck with your decision.

It's interesting though that you apparently went from passive to PP to an advisor, without going through the step of identifying actively managed funds on your own.  (If I am mischaracterizing this, please forgive me.)

I am familiar with many of the funds above and a number of them have very limited histories.  Some of the others are "worst in class"... I'm speaking especially of HSGFX.  I expect you'll be very unhappy with that fund until we get into a cyclical bear market.  The manager is a permabear and he has a history of ignoring his own analysis and not investing in bull markets, and giving every excuse in the world for his extreme underperformance.  He is his own worst enemy.

I hope you're not locked into these funds.  You could do better on your own selecting funds with managers who have performed during bull and bear markets and have a history of at least 15 years, preferably more.  There are some excellent fund managers out there who understand markets, macro-economics and even the role of gold in a portfolio.  You do have to spend some time analyzing funds and managers if you want to go that route, so I can understand the impulse to turn things over to an advisor.  But I can't honestly say that I am impressed with the funds that he/she has selected for you (although there are a few that I consider good).

Again, good luck, but try and see if you have some of your own leeway.  Turning everything over to a FA can be very risky.  At the very least, try to do your own research to understand the funds you are getting into.

And to avoid against manager risk, maybe add some PRPFX. 

Kevin- appreciate your comments however I am interested in "risk conscious" managers with the intent to invest with them over an entire market cycle.  The more I hear people venting their frustration about Hussman the more I want to add to my HSGFX position. 

The obvious fund that comes to people's mind is Fairholme however look what happened to that fund in 2008.

[moda0306]

I tend to divide assets into two categories nowadays (after reading up on the PP).  1) assets that oppose each other for fundamental macroeconomic reasons (and therefore when combined can become more than a sum of their parts), and 2) assets that have to stand on their own.

It is difficult for the latter to ever eclipse the former.  On top of all the excellent questiond MT asked, I think one needs to ask what is fundamentally improved about that portfolio.  To me, it wreaks of "false diversification."  A high number of funds invested in does not a diversified prtfolio make.

[Jan Van]

One "good" thing about the crises is that we can now judge funds and managers on their performance over that hectic period. Which is why i like the PP, Hussman strategic total return and Vanguard Wellesley. This should make it easier to judge how much added value an advisor can bring to the table...

[hrux]

A few comments:

1. How have you had your money invested during the years of research regarding the best investment strategy for you?

2. Has your investment advisor provided a history of the returns that his own strategies have provided compared to whatever benchmark he is using?

3. Why so many funds?  It seems to me that almost any investing objective can be achieved with fewer than the 17 funds that your strategy is using.

4. How will you know when to move in or out of the proposed funds?  Are there rebalancing bands?  

5. What kind of fees are associated with the 17 funds in your strategy?

6. How will your advisor be paid for managing your account?  What kinds of revenue sharing agreements or other arrangements does he have with the funds you are going to invest in?

7. Did your investment advisor properly time the internet stock bubble?  Did he sell the high flyers before they crashed?

8. What would make you reconsider your strategy?  What scale of losses over what period of time would cause you to re-think the approach?  

9. It looks like you have no gold in your proposed portfolio.  Do you feel good about that?  Do you feel like your investment advisor has a strong grasp of gold?  I work with lots of institutional money managers and I have yet to meet one who I felt had a nuanced understanding of gold.

Good luck with whatever you decide.

I will try and answer these questions later however the majority of them would require a rather lengthy response. Imagine I'm picked for the first manned mission to Saturn and the r/t travel time will be 20 years.  Assume I have to set up my investments now and can't change anything for 20 years.  If this were the case, I'd invest in a well-diversified portfolio such as Harry Browne's Permanent Portfolio or one consisting of global index funds with instructions to rebalance them once a year.  And I'd throw in some 20-year TIPS, which pay a 2% real yield at present.

But, in reality the situation is not static and I will be able to actively manage my investments.  That means changing the AA as valuations change, selling a managed fund if a key manager retires, buying a new fund for various reasons, etc, etc.   I see all these things as opportunities, not risks.  There are many types of risks in investing: inflation, sovereign debt defaults, currency meltdowns, equity price collapses, soaring bond rates, etc.   The so-called "active fund risk" is the least of my worries.  I'm focused on achieving high absolute, real returns with as little volatility as possible.

I married with the expectation of staying married for 20+ years, but I don't marry my investments.

[moda0306]

Have you thought of the tax-efficiency implications of such a portfolio?

[Lone Wolf]

Most of these funds have fairly high expense ratios (greater than 1% for a substantial majority.)  Yet just about all of them have underperformed a simple 4x25 Permanent Portfolio.

Understand that I believe in low expense ratios, very broad diversification, and that the human ability to predict the future is extremely limited.  (Harry Browne's "Why the Best-Laid Investment Plans Usually Go Wrong" was an incredibly eye-opening read on the flaws and deceptions of active management.)  I say that just so you know what kind of "world view" I'm coming from.

If you're going for the highest possible returns with the least volatility (and it sounds like you are), I can't come up with any reason that this AA would succeed where a basic PP would not.

Since I'm unsure what all of your goals are with this AA, it's difficult to say whether or not I agree that it meets them.  But I don't see why it would necessarily produce low volatility or high returns.  Can you walk us through how this portfolio provides "true" diversification?  I can't see it but this may very well come down to my own shortcomings in understanding it.

[MediumTex]

I once heard someone say that once you have narrowed down a difficult choice to a handful of alternatives, you should choose the one that seems the hardest to you.

The rationale is that any alternative that strikes you as hard is likely to be crossed off the list early on whether it is a good or bad choice, just because people tend to move away from things that are difficult or potentially frustrating.  If at the end of the process of elimination there is still at least one alternative that seems more difficult than the others, it is often the best choice, because even though the tendency toward the path of least resistance normally tends to create a list of the least painful alternatives, a painful one was still compelling enough to make the short list.

For example, here is a list of options for losing weight:

1. Think thin thoughts
2. Make dramatic changes to diet
3. Join a health club
4. Read a book about weight loss

Which one is hardest?  Which one is most likely to be effective?  Which one do most people choose?  Why?

I think that Heather got her list of possible investment strategies down to a few possible options.  From there, I don't know if she chose the one that seemed the hardest from the short list of alternatives.

I hope it works out well, but it seems like there is a lot of room for error in the approach she describes, and a lot of fees to be paid in the process.  One of the things that bothers me is that she has all of the fund fees to pay, AND she has to pay her investment advisor one way or another as well.

[moda0306]

MT,

Not to mention all the taxes that come with any kind of rebalancing or movement into other funds as managers, opportunties, etc change. 

Also, with no precious metals as far as I can tell, one wonders if the advisor has any respect for the PP at all.

[Gumby]

Rebalancing 17 funds may be more complex than you think, and some funds have very high minimums. Just something to keep in mind before you dive in.

Also, consider the fact that taxes and overall expenses are typically the biggest hurdle for any actively managed portfolio.

See: The Index Funds Win Again

Here's a few key quotes from that article, by Mark Hulbert:

There's yet more evidence that it makes sense to invest in simple, plain-vanilla index funds, whose low fees often lead to better net returns than hedge funds and actively managed mutual funds with more impressive performance numbers.
...
That, at least, is the finding of a new study by Mark Kritzman, president and chief executive of Windham Capital Management of Boston... Mr. Kritzman, who also teaches a graduate course in financial engineering at M.I.T.’s Sloan School of Management, set up his study to accurately measure the long-term impact of all the expenses involved in investing in a mutual fund or hedge fund. Those include transaction costs, taxes and management and performance fees.
...
Mr. Kritzman devised an elaborate method to take such contingencies into account. Then he calculated the average return over a hypothetical 20-year period, net of all expenses, of three hypothetical investments: a stock index fund with an annualized return of 10 percent, an actively managed mutual fund with an annualized return of 13.5 percent and a hedge fund with an annualized return of 19 percent. The volatility of the three funds’ returns — along with their turnover rates, transaction fees and management and performance fees — was based on what he determined to be industry averages.

Mr. Kritzman found that, net of all expenses, including federal and state taxes for a New York State resident in the highest tax brackets, the winner was the index fund.
...
Expenses were the culprit. For both the actively managed fund and the hedge fund, those expenses more than ate up the large amounts — 3.5 and 9 percentage points a year, respectively — by which they beat the index fund before expenses.

If such outperformance isn’t enough to overcome the drag of expenses, what would do the trick? Mr. Kritzman calculates that just to break even with the index fund, net of all expenses, the actively managed fund would have to outperform it by an average of 4.3 percentage points a year on a pre-expense basis. For the hedge fund, that margin would have to be 10 points a year.
...
The investment implication is clear, according to Mr. Kritzman. “It is very hard, if not impossible,”? he wrote in his study, “to justify active management for most individual, taxable investors, if their goal is to grow wealth.”? And he said that those who still insist on an actively managed fund are almost certainly “deluding themselves.”?

What if you’re investing in a tax-sheltered account, like a 401(k) or an I.R.A.? In that case, Mr. Kritzman conceded, the odds are relatively more favorable for active management, because, in his simulations, taxes accounted for about two-thirds of the expenses of the actively managed mutual fund and nearly half of the hedge fund’s. But he emphasized the word “relatively.”?

“Even in a tax-sheltered account,”? he said, “the odds of beating the index fund are still quite poor.”?

[hrux]

Hi Heather,

I think I understood where you were coming from and what your goal was.  I'd say most of us are here because we are risk-conscious and believe in investing for the full market cycle.  So I guess my main thought was that if you go the active management route, some managers are better at handling risk and performing in full market cycles than others.  I'd say Steve Romick of FPACX (which you have listed), is much better than John Hussman.  Steve has made his share of mistakes, but he learned from them and moved on, and can rightfully be called a fairly decent fund manager.  Hussman seems to be too rigid to learn from his mistakes and keeps making the same bad mistakes over and over hoping for different results (which I hear is the definition of insanity.  :D )

But the main thing that got my attention (and I apologize if I came across too strong) was the heavy use of funds that use short-selling.  Many if not most market-neutral or long-short funds are inconsistent in their performance.  They often go up in bull markets and down in bear markets, which is the exact opposite of what they're supposed to do.  And the stocks held short are usually done so based on fundamentals, yet it's an odd twist of fate that the fiercest market rallies tend to have the worst stocks rallying and the best stocks lagging, meaning these long-short funds get seriously out-of-whack.  Regardless of whether the long-short picks are done quantitatively or from a bottom-up perspective, these funds can have streaks of unusually bad performance based on just how they are built.  Not meaning to scare you here, just sounding a note of caution.  

Lest I sound too negative, one of the funds you listed, Dreihaus Active Income, is one I've been curious about myself, despite it's rather short history.  One thing that turned me against it at least for the short-term is I don't understand the reason for the large distribution in 2009.  That hasn't been repeated and it seems to be a key reason for it's excellent 2009 performance and thus it's good 3- and 5-year annualized returns.  If you can get a good answer from your FA on what the story was there, I'd be interested.   Check out the following link for info on the distros:

http://finance.yahoo.com/q/hp?s=LCMAX&a ... f=2011&g=v

Best,
KevD
[/quote]

KevD- appreciate your comments and input.  To address your comments:

Hussman did modify his approach on several occasions. The modification he made to account for his perceived changes in market conditions in 2008-09 has turned out to be to the detriment of investors. He has again made some modifications to allow for more transitory market exposure and less rigidity in the future. So I don’t think it’s entirely fair to say he keeps making the same mistakes. It is fair to say he has been very wrong for the last year+. But I believe he was wrong for the right reasons. He was not going to subject his investors to potential large losses by taking what he viewed as excessive speculative risk. I am looking to invest for the future, not the past. While 10 years of history is informative, it is of little value in predicting the future. If Hussman had decided to ride this market back up and it worked, does that have any bearing on whether he will be right the next 10 years? If I looked only at the numbers one may draw that conclusion. That is why I believe numbers alone cannot be relied upon. Especially if you are concerned the future may not closely resemble the past. Remember we are looking to what we think will work in the future, not what has worked in the past. If you do want to look at the numbers however, you will see that Hussman has significantly outperformed the S&P 500 with less than half the volatility over  his 10 year history (if you choose SD as you preferred risk measure). If you look at calendar years you will see he was never down more than 9%. This includes a period where the S&P had down years of -22% & -37%. As bad as he’s been recently, his track record is still pretty good if you rely on just the numbers.

Agreed on the long short comments, but that is why my advisor uses COAGX. They are one of the few with reasonable expenses where those comments do not hold true. You look at any down period by day, week, month, or year and you will see they’ve done their job of minimizing downside. Also, note that while other vehicles my advisor uses short, C&O is the only one where the primary strategy is long short stocks. In most other cases, shorting is not a major component of the strategy and is often used as a hedge. C&O is also an example of how a manager can look really smart or very foolish depending on your evaluation period. If you want to look at C&O’s 5 &15 year track record relative to the S&P 500 they look very smart. Matched or beat the S&P 500 with a fraction of the volatility and with little downside (-6.5% worst calendar year). I believe this is a good component for an investment strategy based on the present risks & rewards in the marke. You are also very right about inconsistent performance of these types of funds. Having an advisor who is using a clients objectives as their benchmark, rather than an index, I don’t need to be as worried about short term deviations. It is my advisor's job to educate and keep clients focused on the long term strategy. If you are in a position where you are advising a retirement plan you may not have that luxury.

This is the story with Driehaus. Before 2010 they used a tax method where they marked the portfolio to market at year end and investors were taxed on realized and unrealized gains. In 2009 after the credit market meltdown, they took a meaningful directional position in corporate bonds (they can and do take directional positions, long or short, that are not entirely hedged). Because the fund was up significantly in 2009, the distribution was significant. They changed the tax method in 2010 and will no longer be taxed on unrealized gains. It will be taxed as a traditional mutual fund. They are also considering moving to quarterly distributions, rather than once per year. According to my contact this is likely to happen this year. Also be aware that the fund is set to soft close at the end of Feb. so your window is closing and may want to add a small position if you feel inclined.

Hope this helps clarify......

[Storm]

It is fair to say he has been very wrong for the last year+. But I believe he was wrong for the right reasons. He was not going to subject his investors to potential large losses by taking what he viewed as excessive speculative risk. I am looking to invest for the future, not the past.

Wow, just wow.  Since 2009, we have seen the most meteoric rise in the stock market.  A monkey throwing darts at a board with the S&P 500 on it could have had 20-30% growth.  I would run, far away, very fast.  If you cannot make money in a market as bubbly and frothy as we have had since 2009 and the FASB accounting rules change allowed the banks to "cook the books", you cannot make money in any market conditions.

[moda0306]

Am I witnessing an episode of E-Punk'd? 

[hrux]

MedTex- to answer your questions:

A few comments:

1. How have you had your money invested during the years of research regarding the best investment strategy for you?

As an advisor operating customized service in the past we never had composites. To accommodate investors who wanted some feel for performance we showed representative sample, net-of-fee performance for live client accounts. These did quite well and beat the Barclay’s/LB Agg and S&P 500 with limited volatility.

2. Has your investment advisor provided a history of the returns that his own strategies have provided compared to whatever benchmark he is using?

IMO each of these funds adds something unique to the portfolio. We are trying to exploit a niche in the markets it requires a specialized fund with specialized expertise. For example. If we are seeking managed futures, credit arbitrage, and non-agency MBS exposure we don’t want just anybody managing that portion of the portfolio. We want a specialist. This is one reason we have so many funds.

The second reason is diversification. IMO, we are in an environment where investors must expect the unexpected. The risks are far greater than they know. Traditional asset class diversification is important as always. Protection should also be offered against extreme outcomes. Another form of diversification is manager diversification. While conventional wisdom tells you that you don’t want two of the same thing, I believe this is often the wrong approach to take. In a very simple example, if one is indifferent about the prospects of two index funds that track the same index with the same expenses, but are offered by different institutions should you choose one or two? I believe you should split your allocation because you are reducing risk without reducing returns, or increasing expenses or taxes. While we don’t view any of our holdings as clones, we are concerned with manager risk. If we can diversify managers without diversifying away “alpha”? (for lack of a better word), we view this as a positive attribute.

3. Why so many funds?  It seems to me that almost any investing objective can be achieved with fewer than the 17 funds that your strategy is using.

If opportunistically invested in a fund to capitalize on an a perceived opportunity, we will move out of the funds when the risk/reward no longer favors investors. TIPs were a recent example. When real yields recently turned extremely low and even negative at the short end of the curve, we no longer believed the risk/reward was favorable enough to justify an allocation to TIPs. This is primarily a function of valuation, but technical factors are also given consideration. While we will make every effort to remember the market is far smarter and more powerful than any individual player, I will never again subject myself to rigid asset class minimums out of fear we may temporarily deviate from the market. We don’t take reallocation decisions lightly, but would rather do what we believe is right than subject myself to undue risk. Discipline is of great importance when investing, but this is a market where experienced investors, and students of history and macroeconomics can add great value by supplementing allocation decisions with sound judgment in my opinion.

4. How will you know when to move in or out of the proposed funds?  Are there rebalancing bands? 

See #3 above...

5. What kind of fees are associated with the 17 funds in your strategy?

I believe the current fees (0.95%)  are justified given market conditions but believe they are too high for the long-term and expect these to be lower in the future. High fees reduce client returns which is detrimental to them.

6. How will your advisor be paid for managing your account?  What kinds of revenue sharing agreements or other arrangements does he have with the funds you are going to invest in?

Paid 30bps by client only.  Is a true fiduciary and does not receive any soft compensation.  He conducts on site due diligence, meets with managers and has monthly conference calls ewith each fund manager.

7. Did your investment advisor properly time the internet stock bubble?  Did he sell the high flyers before they crashed?

Avoiding that bubble was an easy call. While the cap-weighted P/E for the S&P 500 was 33, the median P/E was 12 near the peak. Shifting the portfolio to small cap, value, fixed income and REITs (8% yields) was an easy choice for my advisor. Not only could you avoid unsustainable bubble valuations, but there appeared to be great value in other areas and asset classes as noted above.

8. What would make you reconsider your strategy?  What scale of losses over what period of time would cause you to re-think the approach? 

The biggest risk of the strategies as currently positioned is underperformance of a market index. Because we view our true benchmark as each specifics client’s objectives we aren’t worried about that (unless beating the index is the client’s objective). We would re-think our approach if 1) a sustainable foundation for economic growth appeared to be in place or 2) An asset class such as stocks became cheap enough to reflect the existing risks (corporate bonds in 2008 are a great example, the outlook for the economy was scary but the bonds became so cheap that anything short of a great depression was likely to be good news for them).

9. It looks like you have no gold in your proposed portfolio.  Do you feel good about that?  Do you feel like your investment advisor has a strong grasp of gold?  I work with lots of institutional money managers and I have yet to meet one who I felt had a nuanced understanding of gold.

In summary, we are not opposed to gold at all and feel investors who are interested may want to own and hold separately as insurance. From an investment perspective, we have bought gold in the past and would do it again. However, if it is done for investment purposes we want to buy when it the risk/reward appears better. If held for insurance purposes paper gold is not the best way to go. Own the physical.

Good luck with whatever you decide.

[MediumTex]

I didn't completely follow all of those answers, but that is helpful.

I didn't see a track record of the advisor's past performance.

The one thing that jumped out at me is you are paying 1.25% in fees between the funds and the advisor.  That's a stiff headwind to overcome, especially in periods where good returns are hard to come by.

The comment that gold may be held as "insurance" is interesting.  Insurance against what?  I assume insurance against the other assets in the portfolio underperforming, which would make me want to incorporate it into the original strategy as more than an afterthought.

I assume some of those responses are from your advisor.  He/she uses an investing version of "consultant-speak", which some people simply can't help.  Sometimes it is harmless, other times it can form a veneer to conceal gaps in understanding.  For example:

We are in an environment where investors must expect the unexpected. The risks are far greater than they know. Traditional asset class diversification is important as always. Protection should also be offered against extreme outcomes.

This is a meaningless statement that could have been taken from a fund's annual report.  It bothers me when I hear people talk like this.  As I said above, though, sometimes people just say things like this out of habit and they are otherwise good thinkers.

[moda0306]

MT,

I feel like this advisor's trying to build a Rube Goldberg-esque mousetrap because it's fun to look at, and he's forgetting that the purpose of the mousetrap is to catch a mouse, not win the Science Fair medal.

Further, to say that we need to protect against "extreme outcomes" but not own gold seems a bit odd to me.

[MediumTex]

MT,

I feel like this advisor's trying to build a Rube Goldberg-esque mousetrap because it's fun to look at, and he's forgetting that the purpose of the mousetrap is to catch a mouse, not win the Science Fair medal.

There is a school of engineering that says it is best to build things that are so complicated that only the original designers are qualified to service them.

I see this sort of thing all the time.  It's a favorite of bureaucrats when they are designing regulatory schemes.

[moda0306]

Well if clients were to look at their holdings and see 4 assets, maybe they'll finally learn your job just isn't that difficult after all.

I could see a planner, using the PP as a foundation, taking somebody's risk tolerance, career, goals, family, etc into consideration and changing things a bit based on certain theories about the future, but to veer too far from the PP exposes you to some large risks. 

Maybe certain industries need some of these derivatives and nuanced investments to protect themselves, but the average person is worried about very basic things like the cost of food and travel, the job market, whether prosperity will reign and whether their assets/debts will fall or raise in value/cost.  All of these are very simply addressed and to dive into all these complicated funds from a man who hasn't had a proven record of predicting market events seem asinine to me.

I think we should maybe be a little more blunt to Heather about this strategy... while I hope for the best for her, I don't think this is in any way going to protect her the way she thinks.

Funny thing is, the only way to "beat" the market (as far as I can tell), is to admit that you can't, invest in 4 assets that oppose each other (and that you can count on them continuing to for fundamental macroeconomic reasons), and rebalance when appropriate.  Tadaaa, you have just beaten the market by making these assets more than just a sum of their parts.

[Gumby]

I didn't see a track record of the advisor's past performance.

Even if the advisor provides a track record, it doesn't mean that he or she actually used the track record with any clients. HB talks about this deceptive trick in Fail-Safe Investing. I've been re-reading a few of HB's warnings about "market-beaters" and investment advisors, and I've got to say that Heather, you should definitely read (or re-read) Fail-Safe Investing if you haven't already. HB's advice on minimizing risk is priceless and undeniable. It can save you a lot of pain and grief. Well worth the 30 minutes it takes to read for sure.

Here is one passage that's worth sharing:

If you deal directly with a financial planner or investment advisor who proposes a particular investment or program, and if you don't understand it fully, ask him to explain it for you step by step.

If it's still unclear, ask to have the investment explained again. If you can't follow it on the second go-round, it definitely isn't for you.

However, it may be something you'll understand later. If it seems important to you, perhaps a broker or advisor can provide literature that explains the investment — or you can obtain a book that will teach you what you need to know.

But until you're sure you understand exactly how the investment works, stay clear of it.

Realize, too, that sometimes the problem only seems to be your ignorance or lack of sophistication, when in fact you're being offered an investment or a plan that truly doesn't make sense. Some people might be less discerning than you — or more inclined to assume something makes sense just because they've heard other people praise it.

It doesn't really matter whether they're wrong or you're dense. If you can't understand it, don't do it.

It's hard to believe that anyone can fully understand a 17 fund strategy. Whereas the PP is quite easy to understand: Four powerful assets for the four possible economic environments. Easy peasy.

I am sure the advisor has the best of intentions for his clients. (I also assume the advisor is reading this thread, so I will do my best to be kind...)

At the end of the day there is always a conflict of interest when discussing passive strategies with an active manager. If a client asks a manager about the validity of a passive strategy, his or her job depends on being able to guide the client to active management. There is no other logical outcome when fees are on the line. And yet, the overwhelming majority of active management strategies do not beat the market over the long term when fees are factored in.



Your advisor's expectation of lower expenses in the future sounds very unconvincing. Can you get that as a promise in writing? No, of course not.

Heather.. I, of course, like others wish you luck. But you should be aware that active management has a long, long list of unavoidable risks. You won't hear about these risks from the investment managers, but people lose money all the time when they hand the keys to their finances over to others.

If nothing else, I do encourage you to order a copy of Fail-Safe Investing from Amazon, ASAP. It may be the best $11 you ever spend: http://amzn.com/031226321X

[hrux]

The comment that gold may be held as "insurance" is interesting.  Insurance against what?  I assume insurance against the other assets in the portfolio underperforming, which would make me want to incorporate it into the original strategy as more than an afterthought.

By insurance  the advisor means insurance against systemic collapse, not other assets underperforming. Short of systemic collapse, gold is not the only way (or maybe even the best way) to protect a portfolio. The managers the advisor has designated as flexible core have the ability to hold gold as part of their allocation. He currently does not have a dedicated position outside of that at this time.

If you haven't heard it, this a good Buffet quote on gold. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"

Do I really want to permanently allocate 25% of my entire portfolio to gold?

[hrux]

Hi Heather,

Thanks for your comments and for the info on Driehaus.  It's an interesting fund, and now that you've filled in the blank about the distro, that enables me to re-evaluate it without a question mark hanging over it.

I do have to agree with Storm about Hussman...(and I promise, this is my last post on the guy!  )  John is an extremely bright guy when it comes to the economy.  He also has a fair knowledge of the market.  But that's not the same as knowing and acting on the right strategy for the market.  Even average Joes like myself figured out that the Fed and such things as the repeal of M2M were all that mattered in this market.  It doesn't matter that the rally is manufactured and based on a house of cards.  What matters is that the Fed is pumping trillions of dollars into the market to make the house of cards stay up...at least for a little while.  If a fund manager can't take advantage of the short-term momentum and at the same time put on hedges (gold, cash, shorts, etc.) to protect against the inevitable fall, then in my own opinion, that manager should be fired.  Yes, John will have his day, but anyone investing in his fund may have to wait a year or so until the current cyclical bull, however fake, is over.  In the meantime, they've squandered a once in a lifetime chance to drink freely at the Fed's punchbowl.

Anyway, best to you in your investments.  While many of us might not agree with you choices, it's clear to me that you have given these funds a good deal of thought, so you're not going into them blindly.  I wish you all the success.

Best,
KevD

"Even average Joes like myself figured out that the Fed and such things as the repeal of M2M were all that mattered in this market."
So if this is true, wouldn't it have been prudent to overwieght stocks and not subject 25% of your PP portfolio to certain 0% returns in cash? Seems to me that you believe you can predict the future.

"It doesn't matter that the rally is manufactured and based on a house of cards".
Here is another problem that I have with blind index exposure to the market under all circumstances. Do I really want to expose 25% of my portfolio to something I describe as a house of cards? Not with my money...

[MediumTex]

I would probably want to talk to a few of the advisor's other clients as well, preferably those who had been with the advisor for at least a few years.

It might give me a comfort level if I talked to others who had actually lived with the advisor's strategies through some difficult markets.

...if I were in the market for active management, that is.