Monday, 27 March 2017
Last updated 14 min ago
Jul 27 2009 | 11:42am ET
By Emanuel Balarie -- For many years, investors have maintained a rather simplistic, almost dogmatic, approach to investing. This strategy entailed purchasing an asset that you believed would head higher- and holding it until it became profitable. Generally speaking, this approach was most applied to the equities markets and was further reinforced by Wall Street. If an investment would go against you, your broker might advise you to “cost average” your investment. If you wanted to “take your profits” or “cut your losses” they might quickly remind you that “market-timing” has historically underperformed a typical buy and hold strategy.
More recently, this “buy and hold” strategy has grown to apply to all types of investments, including real-estate, private equity and commodities. The idea that prices could come down or that market conditions are not always predictable was somehow forgotten by investors. Indeed, while this buy and hold strategy worked well during the bull market reign, it quickly failed as the recession and credit crunch forced virtually all markets to head substantially lower.
The Rise And Fall of College Endowments
A poignant example of this overexposure can be seen by the recent performance of college endowment funds. A couple of weeks ago, Barron’s Magazine ran an article in which they looked at the “Rise and Fall” of the investment genius that was- college endowments. The article started off with the following summary:
FOR YEARS, TOP UNIVERSITY ENDOWMENTS at Harvard, Yale and Princeton were the envy of the investment world, thanks to the outsized returns they generated from significant investments in nontraditional assets such as private equity, real estate, hedge funds and commodities, and low exposure to U.S. stocks and bonds.
Now that widely imitated asset- allocation strategy, dubbed the Yale model because of the enormous success of the Yale endowment under the 24-year leadership of David Swensen, is facing its sternest test amid the bear market of the past 12 months. Harvard and Princeton are assuming their endowments fell about 30% for the fiscal year ending June 30, while Yale is projecting a decline of 25%.
At one point, the endowments’ trail blazing approach was lauded by many investors as pure genius. However, it is quite clear that their approach was much more similar to an average Joe investor who religiously purchased company stock in his 401k than to a market guru who could adeptly navigate through a changing investment landscape. It is true that they ventured into “alternative investments” and diversified away from traditional investments. However, bear markets – and liquidity crunches-wreak havoc on all types of assets. Ultimately, their “buy and hold” strategy that worked so wonderfully well during the bull market reign, failed miserably during the new market conditions.
Where Do We Go From Here?
Harvard, Yale and Princeton’s investment woes are emblematic of the struggles that most all investors have had deal with in the past year. Not only do they have to deal with the decline of their investment portfolios (in the case of the college endowments, it means cutting back jobs, etc), but they have to re-evaluate their investment strategy all together. Should they revert back to their asset allocation models that employ one single trading strategy- buy and hold? Or should they consider a more strategy-focused model.
Strategy diversification is an investment portfolio tactic that focuses more on diversifying your funds across a variety of non-correlated investment strategies, than on diversifying it across different asset classes. With asset allocation, the underlying assets are what determine whether or not your portfolio will make money. For instance, if you happened to purchase gold at $300/ounce…and gold headed higher, it was the actual gold investment that contributed to your returns. With strategy diversification, however, investing in the actual trading strategies of the advisors will ultimately dictate your portfolio returns.
From Asset Allocation To Strategy Diversification
Indeed, it can be argued that the asset allocation model that was developed by Wall Street has extreme limitations. While much of the focus on that model is based on diversifying among different asset classes and finding investments that are non-correlated to each other, the model failed to provide investors with the benefits that it has espoused over the past few decades. Why? Well simply put, investors quickly found out that there investments were more highly correlated then they initially thought.
Had investors invested in other strategies that were not buy and hold, they might have had an opportunity to profit from the markets. Or, at the very least, soften the decline of their investment portfolios.
To be fair, the ferocity of what transpired in 2008 took many people by surprise. And it is also fair to say that there are legitimate benefits to implementing a buy and hold strategy. However, investors should learn from this recent decline and understand that “buy and hold” is one of many different strategies. If portfolio diversification is ones true objective, strategy diversification is just as important- if not more so- than the underlying investments.
While some might argue that this analysis is backward looking, I made a similar point about the limitations of “buy and hold” strategies in July of 2005:
“Sometimes being fundamentally correct can be monetarily wrong. Too many advisors today espouse their economic views, while disregarding the idea that trends often ignore fundamentals and can last far longer than fundamentals may dictate. By stubbornly holding on to a certain view on the market, investors and/or advisors can either miss out on potential gains or may even give back some of their accumulated profits.“
This is exactly what happened in 2008. The managers that stubbornly held onto their “buy and hold” strategies experienced losses in their client’s portfolios. Conversely, advisors that happened to participate in non-buy and hold strategies were able to have some profitable investments. Perhaps the most talked example is that of the systematic trend following strategy that some Commodity Trading Advisors employ. The trend following strategy was successful because the CTAs were able to trade both sides of the trend. Most trend followers made money as commodity prices were heading to record highs in the first part of the year, and they were also made money as they drastically retreated in the second part of the year.
Even though trend followers are the most recognized of CTA strategies, it is important to point out that on a standalone basis, their strategy is no more diversified than that of “buy and hold.” In the same manner that there are market conditions that are not ideal for implementing a buy and hold strategy, there are also market conditions that are not ideal for trend-following strategies. As such, it is important to invest in a variety of trading strategies if one is to achieve a greater level of portfolio diversification.
Going forward, I believe that there will be a greater focus on strategy diversification. Investors will not put up with only having a “buy and hold” strategy in their portfolio. Rather, they will want to have portions of their portfolios that have the ability to profit from a diverse array of market conditions. Does this mean that all of these “non -buy and hold” strategies will make money all the time? No. It also doesn’t mean that “buy and hold” no longer has a place in an investor’s portfolio. However, it does mean that there will be a greater focus on investment strategies that are unique and can generate returns in a variety of market conditions. In short, investors will demand returns regardless of the dismal news, benchmark performance or market conditions.
Emanuel Balarie is a managing director at Balarie Capital Management. The firm works with high-net-worth investors, family offices, pensions, and endowment funds interested in adding managed futures to their investment portfolios. In addition, Balarie Capital Management offers clearing and execution services for CTAs, fund of funds and professional traders. Balarie is also the publisher of the online industry resource Commodity News Center and Managed Futures Quarterly.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW THE CTA’s DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM.