STICK TO YOUR STRATEGIC ASSET MIX — OR FACE THE CONSEQUENCES
Tactical moves should be the exception, not the rule, Tom Bradley writes.
My partner, Salman Ahmed, has a good way of provoking me. Just when I’m getting too comfortable with a view or strategy, he asks a penetrating question. One of the most effective ones is: “Why wouldn’t we be exactly on our long-term asset mix?”
In this case, he’s referring to the mix in our Founders Fund.
The question is important for two reasons. First, your strategic asset mix, or SAM, is the most valuable tool you have for balancing return and risk. It’s the blend of security types (cash, bonds and stocks in this case), industries and geographies that give you the best chance of meeting your investment objectives. Disciplined investors give their SAM a lot of thought, so it’s not to be ignored.
The second reason relates to the fact that enhancing returns through asset mix shifts or industry sector rotation is hard to do.
Some would argue it’s impossible.
So, to Salman’s question, there must be a really good reason for not being on your SAM.
REASONS TO DEVIATE
First, if you have unanticipated spending needs, an adjustment to your mix is in order. Money needed in the next two years is not suitable for long-term investment and the uncertainty that goes with it. You’ll want to put it aside in a secure savings vehicle.
Second, if your life situation changes significantly, you’ll need to rethink your SAM.This is a big decision that should be deliberated on and, if at all possible, not undertaken when markets are gyrating. It’s too easy to let short-term news and emotions influence what is a long-term decision.
As for tactical changes to asset allocation, I take an “approximately right” approach, which means moving gradually and only acting on extremes. By extremes, I mean times when valuations in an asset class are meaningfully above or below historical ranges, which is a tipoff that future returns are going to be lower or higher than historical averages. Of course, the timing is never exact.
I should mention that distorted valuations aren’t always enough to prompt a move away from SAM. Extreme investor sentiment, whether it be fear or greed, may also be a trigger. For example, when price-to-earnings multiples are low and investors are running for the hills, it’s time to buy stocks.
WHAT IS EXTREME?
Let me give you a current example. Over the last few years, interest rates have been low and the yield on government bonds has been running below the rate of inflation. With a real yield at zero or in negative territory, holders are destined to be no better off when the bond matures (i.e. no increase in purchasing power).
At the same time, we’ve been witnessing cyclically low credit spreads. Spread is an industry term for the extra yield an investor is promised for holding a riskier corporate bond. A narrow spread implies less reward for the same amount of risk.
This combination of zero real yields and narrow credit spreads has meant the Founder’s Fund holds more cash in lieu of bonds. Yes, boring short-term notes that don’t yield much, but have a similar return expectation to bonds and are more defensive in a rising rate or weakening credit environment.
REASONS NOT TO DEVIATE
Inexperienced investors who are doing it on their own should always be glued to their SAM.
For the rest of us, tactical moves should be the exception, not the rule. They shouldn’t be prompted by elections, trade negotiations, a hot tip in the locker-room or a dire prediction from a neighbour. In other words, news feed items rarely justify action. As Warren Buffett said, “Wall Street makes its money on activity. You make your money on inactivity.”
Neither should you change your asset mix to pursue a specific theme like alternative energy, AI, blockchain or pot. Being disciplined about your SAM doesn’t preclude you from buying stocks in these areas, but it needs to be done in the context of your overall portfolio. You’ll need to reduce your equity holdings elsewhere.
My message here is simple. Your SAM is super important. Stick to it unless you have a really good reason to do otherwise.