Search for Safety and Alpha-December 2, 2008

December 2, 2008

We’ve just completed a study of investment management alternatives, following a rather damaging year for our personal investments and those of our favorite charities. Initially, we had hoped to find that our investment manager erred in not changing allocations, and at least come away with a better model to address the next cycle. We wanted to find a solution that would capture upside, but would adjust to minimize downside when storm clouds begin to form on the horizon, next time around.

It turns out that (so far) we did not find any such hope: While various managers all promised to do a better job for us than what we have experienced, there were several problems in giving credibility to such assurances. One problem is that those with measurable results all had performed similarly to our existing manager–about the same as the market, a little better or a little worse. Some do not manage money and only advise, so they were prevented from showing client specific results. Another problem is that none of them actually claimed to have avoided the fall this time around. Furthermore, they all ultimately admitted that the purpose of their arcane metholody of risk and volatility tolerance (resulting in recommended allocations) never pretended to include frequent or dramatic shifts in allocations, such as to try to take advantage of opportunity or to prevent damage. God forbid–that would be a kind of market timing! To the contrary, the picture was one of setting the allocations and leaving them alone, except for periodic rebalancing to the original allocations. In this way, provided the underlying allocated investment tranches of domestic and foreign stocks, government and private debt instruments, etc, are all managed reasonably well, there would be upsides and downsides, both potentially beyond what you expected, but relative to the market either shallower (less return long term) or more pronounced (more value long term), but in accordance to your relative tolerance for risk and volatility.

We suppose this makes sense. After all, if anyone had the crystal ball, wouldn’t she/he have all the money in the world to manage by now, or wouldn’t that magic have been copied by thousands of others so that we’d all have access to it? When we see the fall of such as Harvard, Stanford, Legg Mason, Dodge & Cox, and hundreds of others who enjoyed such remuneration and such esteemed wisdom, we suppose there is some small comfort to us little people, that we didn’t fail so very totally to grasp something that might have saved us.

Seems to us that the only people who truly avoided this catastrophe were those who went to cash or went very short. The first strategy is mostly made up of ultra conservatives who enjoyed none of the upside because they saw the storm clouds for years or had no risk tolerance. The second is home to a small group of high flyers, some of whom have been squeezed out, even in this market, because the fall has not been steady and continuous.

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