Our Goal Isn't a Resilient Portfolio. It's a Resilient Investor.

Sample 2020

From the December 2019 issue

A LARGE, WELL-KNOWN ASSET MANAGEMENT COMPANY IS running a major marketing campaign under the headline “Confidence starts with portfolio resilience.” This statement seems to me exactly wrong.

The campaign goes on to offer a brace of white papers around the theme of managing portfolio volatility as a means to the end of investor confidence: “The use of futures, options and dynamic allocation can be valuable components in an intelligently constructed hedge.” This statement is inarguable, as far as it goes. But like all the multifarious strategies offered by the investment product industry in the nearly 11 years since the bottom of the Great Panic, it begs the question.

That question, of course, can only be, “Please, sir: how much of equities' superb long-term return do I give up in order to acquire your (and I quote) intelligently constructed hedge?” Because if one could get a straight answer to that question—which one never can—one could then ask the corollary question, “Am I prepared to give up that much of equities' return in order to buy (and I quote) confidence?”

For as long as I can remember, investment products have carried the warning “Past performance is no guarantee of future results.” Incurable optimist that I am, I look forward to a day in the far distant future when all products alleging to manage or mitigate equity volatility are required to disclose that in an efficient market, anything that suppresses equity volatility must commensurately suppress equity returns. As this marketing campaign amply demonstrates, that day is not yet here.

Instead, all such approaches claim to mitigate the downside while “participating” in the upside—whatever that's supposed to mean—and offer that most nebulous of objectives, a superior risk-adjusted return. They peddle the toxic illusion of asymmetric risk management: that it is somehow possible consistently to suppress volatility more than one suppresses return. This is fantasy. It requires belief that the market itself is inefficient, and/or that one's management team can consistently arbitrage temporary inefficiencies as they occur (and before all the other algorithms in the world pounce on them). I say again: fantasy.

But even that isn't the primary issue here, which is that portfolios don't give people confidence; people give people confidence. That is to say that the advisor—the Behavioral Investment Counselor—gives the equity investor confidence that he can't generate on his own. Specifically, we give people confidence that equity market declines are always temporary, while the upward march of equity values and dividends is permanent. And that full participation in the bounteous returns of equities is available only to those willing to ride out the temporary declines.

However it's practiced—through hedging, market timing (“dynamic allocation”) or “alternative investing”—asymmetric risk management is premised on the cynical assumption that advisors can never control their clients' destructive emotions, so the portfolio has to do it. But it can't, and in the process of pandering, the clients' long-term return gets ground down to the point where his most cherished financial goals become unattainable.

The pre- and post-retirement financial goals of just about everyone we're ever going to meet cannot be achieved without an overwhelmingly preponderant commitment to equities. Equity investing, in turn, is one part intellectual to 19 parts temperamental—and virtually no one has the required temperament unless he/she is coached by an empathetic but tough-loving Behavioral Investment Counselor. The portfolio can't administer the serum; only a person can do that.

The ultimate message of this essay to NMI readers is how little actual competition you have. Even as the equity market streaks toward a quintupling of the March 2009 lows, whole marketing campaigns such as this one continue to be built on the pathology that mistakes temporary decline for permanent loss.