We explore what strategy and systems are and how we craft and change them. We consider how investment strategies and financial systems have changed over the decades and why this matters to your financial decisions.
Show Notes
Ruminating on Asset Allocation by Howard Marks—Oaktree Capital
Michael E. Porter—Harvard Business School
This Is Strategy by Seth Godin—Simon & Schuster
Victor Meets the Boglehead by Victor Haghani & James White—VettaFi Advisor Perspectives
Static vs Dynamic Asset Allocation; Victor Meets the Boglehead—Bogleheads.org
Tim Cook on Why Apple’s Huge Bets Will Pay Off By Ben Cohen—The Wall Street Journal
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Related Episodes
491: The Five Layers of Investing
451: How Much Should You Invest in Stocks? The Art of Position Sizing in a Volatile Market
420: Does a 60/40 Balanced Portfolio Still Work?
397: How To Invest Based on Cycles
Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 501. It’s titled, “Strategy and Systems Want Your Money.”
Asset Allocation
I recently read a memo by Howard Marks. He’s the co-founder and co-chair of Oaktree Capital Management, a firm that I invested with at my old advisory firm. He’s the author of Mastering the Market Cycle. We discussed his approach to investing back in episode 397. We always link to related episodes in the show notes of the podcast, so you can check out that episode link there.
In his memo, Marks, who I believe is in his late 70s, wrote: “From my vantage point, asset allocation is a relatively new thing. No one used that phrase when I joined the industry 55 years ago.” That would have been back in 1969. “Structuring portfolios was a pretty simple matter. Following the classic 60-40 split. Most US investors limited themselves to investing in US stocks and bonds, and there was a time-honored notion that something like 60% equities and 40% bonds represented reasonable diversification.”
Marks continues that now investors have so many choices and that the term asset allocation is very prominent. There are individuals in whole departments dedicated to doing asset allocation, which means to decide the weight of asset classes to be held in a portfolio.
And so he lists off questions that are asked as part of the asset allocation process. How much in stocks, versus bonds? How much in alternative investments, which includes private capital, such as venture, buyout funds, real estate? How much in one’s home country, versus outside of one’s home country? How much in developed versus emerging markets? How much in high-quality assets versus low-quality? How much leverage do we use? What about derivatives?
These are all questions we’ve covered on episodes of Money for the Rest of Us because my background as a professional investor and advisor is asset allocation.
When I got into the advisory business in the mid-90s, a typical client that we would bring on were using maybe two managers, and they were balanced managers. The manager might be running a separately managed stock account, picking individual securities, perhaps 40 to 50 stocks, and they would manage a bond account, selecting individual bonds.
And the allocation weight was typically 60/40. We would go through an asset allocation study with the client. We would introduce the concept of international diversification, allocating to small-cap stocks, which typically weren’t always represented in the portfolios. The 60/40 portfolios typically would be heavily weighted toward large company stocks.
We would structure a traditional portfolio. It was style-neutral, so there would be elements of growth-style investing, value-style. Most of the assets were using either separately-managed accounts or mutual funds. There was a focus on adding value through manager selection, who in turn were trying to generate excess return through security selection.
That was the approach for the first seven years or so of my advisory career, and I’ve found it frustrating because these managers would often underperform. There was constant pressure from the investment committee to fire an underperforming manager and replace them with an outperforming manager that typically was outperforming in both the short term and long term, which means their style had been in favor over the last few years, and often that manager might get hired, and their style would go out of favor, and then they would underperform.
So it was sort of this manager rotation. We as advisors did not have discretion, in that the committees or the client made the final decision, both as to the asset allocation, as well as which managers to hire.
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