One for the Road (Jeffrey Saut)

This article is a guest contribution by Jeffrey Saut, Chief Investment Strategist, Raymond James.

July 26, 2o1o

“Our approach to asset allocation is focused on wealth preservation by controlling the overall exposure to risk assets in relation to macro conditions, valuation and market psychology. We are not attempting to forecast the specific performance of various asset classes as a means of facilitating market timing decisions, as history has shown that this is rarely a winning strategy. Rather, we will attempt to provide analysis that will help investors play a more active form of defense and offense with their portfolios. In order to achieve these goals, we favour a dynamic approach to asset allocation, reviewing the portfolio and making adjustments on a quarterly basis or as conditions evolve, rather than sticking with fixed allocations come ‘hell or high water.’ Systemic risk in the global economy is far higher than in the previous post-World War II years, volatility promises to remain extraordinarily high and the financial system may be subject to major shocks. This is a major theme running through The Great Reflation. In such an environment, a buy and hold approach to asset allocation will carry a lot more embedded risk than most people expect.”

“In practice, the execution of dynamic asset allocation is subjective and highly complex for global investors. Many attempts have been made to create models or algorithms that rely on indicators to calculate an optimum asset allocation. However, this sort of quantitative approach inevitably breaks down as the assumptions that underpin the model cannot fit every set of economic conditions. We use indicators selectively to inform decision-making, but at its core, asset allocation is an art, involving equal measures of analysis, intuition and common sense. Above all, investors must have a clear idea of their tolerance for risk, exercise discipline and stick to a plan. Some prefer one of rigid allocations and the literature tends to support this approach. We favour a dynamic allocation process which allows for some flexibility in order to better control risk at important market junctures (e.g. stocks in 1999, housing in 2006-2007).”

...Tony & Rob Boeckh, The Boeckh Investment Letter

I have often opined that asset allocation is the key to bringing alpha (read: outperformance) to portfolios. I have also stated I am not dogmatic about asset allocation. For example, I have not owned bank stocks for eight years. I “missed” them going down and have “missed” them going up. Obviously, I agree with the Boeckh’s more “dynamic approach to asset allocation.” To be sure, for years I have advised participants to think of investing for the future as an automobile, conveying investors to their financial goals. The investment portfolio is its motor, the asset allocation model is the fuel mixture, and the invested assets are the fuel. As John Valentine, of Valentine Capital, notes:

“The more efficiently the motor runs, the greater the speed with which the whole vehicle travels toward the destination. Should the fuel mixture, or asset allocation, run too rich, the motor wastes precious fuel. Should it run too thin, the car has trouble achieving enough forward momen­tum... Many individuals on the road to their financial goals fail to make these periodic adjustments and still eventually arrive. Not surprisingly, the investor who rebalances his portfolio at regular intervals may arrive sooner and with more fuel in his tank... Rebalanc­ing a portfolio is crucial to the investor seeking to reduce the volatility in a portfolio and increase cash flow simultaneously... The longer a portfolio is left unbalanced, the more compromised its asset allocation may become. There are two potentially negative repercus­sions associated with a compromised allocation: being overexposed to the downside and underexposed to the upside. Don’t let this happen to you!”