I had an interesting talk with a reporter for a major newspaper yesterday about the debt ceiling issue. She wanted to know what we were doing about it and what changes if any we were making to our allocations.
The reason I found it interesting was that, in fact, as you know, we have been talking about this here in the blog and in Commonwealth’s investment groups all summer. After all, the Treasury hit the borrowing limit in May and has been using extraordinary measures ever since. The fact that the Treasury will run out of maneuvering room in October is not a surprise—or at least it should not be. If we were changing our allocations now, we would be failing in our duty to look ahead.
This gets back to a point I made yesterday, which is that success in investing is largely about making decisions and judgments about what other people are not looking at—or are seeing incorrectly. Often viewed as contrarianism, it is better described as an independent decision process that is not swayed by daily noise or by the gyrations of the market.
Much easier said than done, of course. There are two major obstacles. The first is our own doubts. When we make a decision, how confident are we that we are right? In my own portfolio, for example, I hold some gold. For a while I was very right, and that felt good. Over the past couple of months, I have been very wrong, and that has not felt so good. I have been, and still am, tempted to exit the position—but I am not going to. The reasons I got in still hold. Conversely, I have been very cautious about the stock market all year, even as it has continued to rise. I remain cautious, but I have to admit that it has been frustrating.
The second obstacle is career risk. I can make whatever decisions I want on my own portfolio, but dealing with client money is riskier. When I make my own decisions, I know what I am thinking and implicitly buy in to the decision. I also bear the full consequences when I am wrong. When dealing with client money, an advisor or money manager has to consider whether the client will stay with a strategy, even during the down times.
When a client abandons a strategy, rightly or wrongly, he or she often shifts to a different money manager as well—often to one whose strategy is more in tune with what is happening right now. This is best seen in mutual fund performance. A couple of Morningstar® studies have demonstrated that individual investors often underperform the funds in which they invest by buying at high values and selling at low values—exactly the wrong things to do. Performance chasing is a recipe for poor performance over time, but a money manager has to consider that as a very real risk both to his or her clients and to him- or herself.
I do not have personal clients, but I see this indirectly in talking with advisors. Clients are now wondering why their portfolios are underperforming the S&P 500. Well, they should be, as their portfolios also are designed to have less risk than the S&P 500. Many of these same clients were demanding to be taken out of stocks entirely several years ago—again at the wrong time. For both the individual investor and the professional money manager, the challenge is separating recent performance from the fundamentals and investing for the time frame of the goals. For a client to shift much more heavily into stocks right now, based on recent performance, would in my opinion unjustifiably increase his or her risk. Nonetheless, there are signs that this is exactly what is happening.
To go back to the interview that started this post, what really matters, in my opinion, in setting today’s allocations are the relative valuation levels of the different asset classes and the expected time frame. For expensive assets, like the stock market, risks such as the debt ceiling debate will exacerbate the risks of a revaluation. This is not something new but something we have recognized for some time. Moreover, the specific thing that might trigger that revaluation—Washington, DC; Europe; China; Egypt; or whatever—does not really matter. The risks come from the fundamental situation not from whatever triggers it.
We will continue to try and look around the corner for risks and be very aware of them well before they hit the public perception. That, after all, is quite a bit of what I write about. At the same time, our portfolio construction is based on a longer-term horizon and a wider view of what matters to investment performance over time. Whether you manage your own money or rely on an advisor, I would suggest that that is the approach most likely to generate long-term success.