Sunday, September 13, 2009

Who are Better Equipped
to Make Decisions?

History often seems to be a tale of decisions made by many versus those made by few. Humans recognize that the results of various decisions can turn out poorly for us individually. In search to improve the odds, we crave some form of central authority. In the distant past, people invested these roles of all-knowing and all-powerful in external forces, supported by strong religious beliefs. In more modern times, we have substituted various forms of governments to play the role of God on Earth. The question is, what level of authority should we invest in the government to make critical decisions for us?

After reading the above paragraph, you are preparing yourself for a long polemic about healthcare and the other issues of the day. What follows is about portfolio management, much lighter, but perhaps more immediately meaningful for many investors.

When we seek advice, traditionally we seek “experts.” While various governmental or trade associations require those who put themselves out as “experts” to have passed various examinations about a generally accepted body of knowledge and codes of ethics in dealing with clients, none of these exams measure the success of picking the correct investments. As a very poor substitute for this measure of success, so called “track records” are proffered. As the early developer of one of the largest and most accurate data banks on investment companies (popularly known as mutual funds), I urge caution in the application of these “track records.” The data shown is point to point, is flat and has a lack depth or narrative. For example, earlier this week I was discussing with an associate the search for a new technology focused fund to add to a specific portfolio. My associate suggested a relatively new fund that is managed by a manager who had a very good record in the distant past when technology stocks were flying. I demurred, for I distinctly remembered that the fund in question benefitted from the buying power of its group to load up on “hot” IPOs, between quarterly statements. There are many other examples of important factors that are not captured within performance records.

Worse than an ordinary expert, is a well-known expert or a minor celebrity. I experienced that treatment in my own home Saturday night. Ruth and I were hosting a cocktail party for friends who had recently returned from their honeymoon. The party included many of their long-time friends, some we did not know.

Allow me to make a composite of several conversations. The composite couple (not the newlyweds) had very impressive positions at learned institutions. They wanted a brief shopping list as to where they should invest their money. There was not much discussion as to any of the factors what would go into a proper prescription to their needs.

I found this ironic. While we did not talk current politics with our guests that evening, I am under the impression that they believe that healthcare decisions should be left almost exclusively in the hands of the medical/scientific community, for they are the only ones equipped with the knowledge of what worked in the past (most of the time) and through appropriate diagnosis of a patient, select what would be medically the best solution. They understood the individualized need of the patient but not the investor.

In such situations, some might provide a “school solution.” This approach calls for 30% in money market or other high quality short term funds, 10% in somewhat longer term funds of intermediate investment grade quality bonds, 20% in international or global funds, 20% in domestic-oriented growth funds spread by market capitalization, and the final 20% in large domestic valued oriented stock funds. The advantage of the school solution is that many will adhere to it. Disclosure point: None of the accounts that we manage would follow the exact school solution, as it would not fit their needs.

The school solution would be authoritative, not because I said it, but it is close to the overall mutual fund industry taxable composite.

In the world of investments, be wary of all experts, particularly celebrities. Central authorities lead eventually to unstable conditions, as other solutions prove to be more beneficial for many.

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