Experience
We believe experience accumulated as institutional investors can be helpful for smaller, individual investors.
The fundamental tools and thought processes used by a large pension fund to construct portfolios, allocate assets and source managers are directly applicable to the challenges you face.
Let’s flip the script and use lessons learned to build something useful for you.
Some specific instances we’ve experienced come to mind:
I don’t want to take too much risk in my 401(k), so my allocation is 100% bonds
Taking too little risk is far more common than you may think. We’ve seen significant percentages of 401(k) and 403(b) participants electing to avoid risk. They were underearning due to their asset allocation choice.
If savings plan assets aren’t earning enough, the portfolio is not compounding fast enough to do what it is supposed to do in retirement. To compensate, individuals have to contribute more, work longer or spend less in retirement (or all of the above).
Taking too little risk can be more detrimental than taking too much risk.
Taking risk is something I can afford, and it brings me X% more returns
Though this is often true, what we’ve seen over time is that people put too much emphasis solely on “headline” returns. It is only natural to do so! However, the median return of a portfolio isn’t the only thing to consider and it may not even be the most important thing. What happens over time in a stressed environment — say, at the 10th and 90th percentiles — might be worthy of a look!
We found with a charitable organization the volatility of their portfolio — which drives the “left tail” outcomes — caused the CFO to lose sleep. Portfolio volatility morphs into budget volatility and cascades down, impacting staffing and fund raising.
At an organization fueled by charitable donations, it may be wiser to mute portfolio volatility and mitigate unfavorable budget variances which can raise eyebrows (or worse, trigger an emergency fundraising campaign).
The message is the same for individual investors: portfolio volatility affects your budget, either now or later.
I’ll get back into equities after the “bottom” is in
The saying goes “time in the market is more important than timing the market” and it is sage advice. This truth can be illustrated by looking at the frequency and magnitude of rallies which occur during bear markets. Those aren’t supposed to happen, right? And if you aren’t invested because you are waiting on the sidelines, you’ll likely miss those.
It’s better to get an allocation that suits your risk tolerances — and ability to withstand a drawdown — in a wide array of market environments, gravitating back to that allocation with periodic rebalancing. That way your portfolio has persistent equity market exposure aligned with a risk budget you can afford.
Investment returns aren’t meeting expectations
Some investments come with a lot of hype. Getting a clear-eyed view of what is going on can be hard. The investment lingo in the prospectus can add to the confusion and the time period in question matters a lot. But sometimes, the fees are the main source of leakage.
All fees lower returns, but excessive fees are the most damaging. Be sure to look at returns gross and net of fees. The returns gross of fees may be exactly what you expected to see. If you’re paying for active management but getting returns more similar to passive index returns, that is a problem.
An investment isn’t performing well relative to its benchmark
Performance measurement issues are often due to comparing an investment to the wrong benchmark. Objective benchmarks aren’t always easy to find or understand, and many aren’t investible. Outperforming a benchmark is very hard to do and investment managers have an incentive to argue for benchmarks that are easier to beat.
In these instances, experience is valuable and can eliminate any doubts.
I don’t own what I thought I owned
You assembled a bunch of investments and they all look great on paper. But how do they behave as an consolidated group? Did you accidentally replicate the S&P 500 by putting those things together? If that is the case, you may be overpaying for the services of those asset managers. Does your portfolio really behave any differently than a passive index?
Passive investing is powerful. Buttoning down the amount of equity “beta” you need to accomplish your financial goals can be accessed at very low cost. Then complementing that allocation with exposure to racier, more concentrated active management makes sense as source of additional returns (or “alpha”) produced by skilled managers.
But keeping yourself honest and verifying a specific strategy did what it was intended to do is necessary.
Lending out my securities makes me money
Securities lending is big business. To “short” securities, sophisticated investors borrow securities from other investors. Are you one of those investors? If so, how much compensation did you receive for that? You’re renting out your securities and the income is nice, but is it enough?
In constructing a securities lending facility, we learned a lot about counterparty risks and the mechanics involved in securities lending. Even if that makes your eyes roll back in your head, just know there is risk. You’ll want to think about these opportunities carefully before participating.
We have worked with some of the largest and most sophisticated asset managers, consultants and advisors to produce investment policies, define asset allocations, source managers and generate investment returns which satisfy investment committees. We have a feel what works and what doesn’t.
Let’s take a moment to review the portfolio you’ve constructed and see if it delivers against expectations. If it doesn’t, we can take some time to see what might make sense to tweak or change.