by Jamie Hyndman, Mawer Investment Management
As many have professed over the years, getting asset mix right is a key factor to achieving investment success. Yet there is considerable disagreement as to the best way to make top down asset mix decisions. The two major schools of thought – strategic or tactical – diverge considerably in their approach. While one relentlessly pursues perfection, the other has more earthly aspirations.
The tactical approach involves following a plethora of market and economic data, and making significant shifts in asset mix to take advantage of short-term opportunities. It assumes one can gather all of the relevant data, correctly interpret it, and act on it in an expeditious manner. In other words, it relies on having perfect knowledge of both current and future market conditions.
Sound impossible? We think so. As we describe in this year’s annual letter to clients, “Taming the Mayan”, capital markets are complex, adaptive systems that are driven by a huge number of intertwined variables. Outcomes in this system are largely unpredictable. Ever heard of the expression that a butterfly flapping its wings in Brazil can set off a Tornado in Texas? This is known as the Butterfly Effect and it describes how seemingly innocuous events in one part of a system can have surprisingly large consequences in other seemingly unrelated parts. Capital markets are driven by dynamics like this which make accurate forecasting very difficult.
Four years ago, how many could have predicted the enormous central bank intervention that has come to drive markets higher in recent years? How many today have insight enough to confidently predict the future of Chinese GDP or interest rates? Yet these are precisely the kinds of forecasts that underlie a tactical asset mix strategy.
In contrast, a long-term strategic approach does not try to perfectly time the entry and exit into and out of asset classes. Rather, it seeks to systematically overweight those areas of the capital markets that should outperform over the long-term, while also remaining diversified to ensure overall resiliency in the short-term. For example, our current strategic positioning is built off of the belief that equities are more likely to outperform bonds, and bonds more likely to outperform cash, over the long-term. It is also structured around the belief that global equities are more likely to outperform domestic equities and small capitalization equities are more likely to outperform large capitalization. While we cannot know for certain whether this positioning will play out, there is considerable empirical and deductive reasoning to support it in the long run.
The long-term strategic approach to asset mix can sometimes get criticized for not being dynamic enough. But this is a little like telling a ship’s captain that he must position the ship for every little swell in the sea, instead of steering the ship in the best overall direction to meet its destination. It doesn’t make for a very solid plan. Investors should be cautious of strategies that illogically pursue perfection – they may ultimately undermine the ability to have an otherwise excellent investment portfolio.
Jamie Hyndman
Copyright © Mawer Investment Management
