Spring Cleaning and the Beginner's Mind

The salt and shovels are finally stowed away (and now we remember now why April is called the cruelest month) but spring is finally here and with it always comes a sense of opportunity. Along with the spring clean-outs and green-ups, we thought we would do a little digging in the securities garden.

We were asked recently to construct a portfolio for an athlete, and so went back to drawing board for a fresh start. We wanted to approach things with a new perspective. The Japanese call it Shoshin, or the beginner’s mind. The concept has been summarized as follows: “In the beginner’s mind there are many possibilities, in the experts there are few.” A personal “shout-out” to Kermit the Frog, of Sesame Street fame, who brought it to our attention with his presentation at the TEDx conference in Mississippi. You can Google it and watch.

We firmly believe, and studies have confirmed, that proper asset allocation controls about 90% of your investment results. Harry Markowitz even won the Nobel Prize in 1990 for his work in this area, the Royal Swedish Academy then offered: His theory analyzes how wealth can be optimally invested in assets which differ in regard to their expected return and risk, and thereby also how risks can be reduced.

OK - if your eyeballs are now rolling and “asset allocation” sounds too complicated, unnecessary, or perhaps just outside your “Ken,” just consider what your grandmother used to say, “Never put all your eggs in one basket.”

We would just modify that statement by adding, make sure you know how many eggs to put into what baskets.

Knowing how much and where to invest, is the essence of proper or true diversification. Many well-known companies, in different businesses, can be great investments, but they can also have very similar price performance (this is known as their: correlation). Therefore, owning both does not get your portfolio any diversification. When investing, you need to look at the relationships of your investments (your assets) to each other, as well as the general stock market. The primary goal here, in a market decline, is too keep all your investments from declining on the same day or way.

In our athlete’s portfolio, we set out to create a personal endowment, using a longer term and truly diversified approach. The goal was to obviously grow, but also to protect and preserve his wealth, therefore a primary focus was to minimize volatility.

Note: this strategy also works very well for an inheritance, a judgment, or a divorce settlement. The main difference being the actual core investments will vary for everyone, according to their careers, age, and risk profile.

A good start for our athlete, and most, is to keep things focused on your “goals.” This will help guide you through the investing landscape and help you create a plan in the process. Additionally, we encourage all to create a “satellite” portfolio. This is a separate account, solely for your emergency fund (usually six months living expenses) plus any known cash expenses or required outlays for the next 18-24 months. It’s important to keep these funds in very liquid and safe investments, typically US Government Bills or short notes.

A key fact worth remembering, according to S & P Capital IQ, a “garden variety” bear (down) market, typically lasts about a year and then requires 14 months on average to recover. Also key, Bear Markets don’t preannounce themselves. You don’t want to be forced to raise cash when a normal, and unpredictable, market sell-off logically occurs. This is especially true for things like college tuition bills, or any larger expenses you know about well in advance.

Creating a “core” portfolio of investments, with a longer term horizon, should be the next step. The goal here is to grow, but also to protect. Using a mix of different investments or asset classes, with the proper weightings, and varied correlations, will help keep you on point, by lowering your overall, or total, portfolio risk and volatility.

We are not talking a 1970’s style portfolio of 60 % stocks and 40% bonds, but a 21st century approach. You should be adding other asset classes, like real estate, international equities, emerging markets, commodities, precious metals, foreign exchange, and other alternative assets. This type of mix will give your portfolio more balance, and with the proper weightings, improve your total risk profile. The goal is to lower your overall portfolio volatility, but still get the appropriate return, given your specific level of risk tolerance. Think of it as spreading your investments around strategically, but we call it efficient asset allocation, which focuses on “risk adjusted returns”.

To this end, Exchange Traded Funds (ETF’s) are a great tool, we use them to help achieve proper balance and true diversification. They offer instant liquidity, as well as a specific industry, sector, style, or just a “rules” based investing focus. They are very efficient due to their low costs and are evolving daily.

We were digging through some of the newer ETF’s recently and found some great new versions of some old standbys, those we feel will really sharpen the focus of certain strategies. Some focused on dividend “aristocrats,” some improve the strategy of Gold Miner investing, others hone in on technology within the emerging market sector. Issuers are rapidly creating new ways to isolate certain market “factors”, the primary focus, these are often referred to as Smart Beta strategies.

These are typically well-known investment strategies, long studied, now back tested, and proven to add significant value over just plain indexing. If you consider that over the last 10 years nearly 82% of active managers underperformed these indexes, just a few little tweaks can really add real value to your investments.

We would be happy to discuss the details further, or you can see more market based commentary on our website www.oceaniccap.com.