Singular vs. Diversified Investing
Charlie Munger reminds us that the great fortunes that have been made come from entrepreneurs who focus on one product or service and do it very well.
In maximizing their sound bites or column inches, the talking heads of the news media often focus on a single concept or instrument. While this specific input may be helpful if someone is looking to add to his or her portfolio, following the advice is verging on the irresponsible in terms of how it affects the whole portfolio and the total financial condition of the investor.
Recently I have been researching the impact of ETFs and other pre-packaged instruments and I found that many of the holders of these instruments don't understand the changes in the market mechanisms about trading in and through ETFs. Further they are confusing the difference between individual and team performance.
The Analysis of Picking Winners
As my readers know, I learned much about analysis by handicapping at the racetrack. In order to cash winning tickets it is not enough to find the fastest horse based on its prior races, work outs, breeding, jockey and trainer capabilities. One also needs to guess how the other horses are likely to run in this particular race. If the fastest horse in the race is your choice you would be better off if the horse is not blocked by a crowd of horses running similarly. Some horses with early speed that soon tire could help the ‘come from behind’ horse. Thus, in picking an instrument it is important to have some idea what the other major securities are likely going to be doing. Therefore the length of the race is important. In short races the ability to rapidly accelerate and maintain the acceleration until the finish line is critical to winning. In much longer races stamina is a good deal more important.
Picking Your Measurement Time
When a prospective investor asks me for a recommendation, I ask “What is the period of preferred measurement?” This is like asking the length of the race. To aid the investor, I introduced the concept of the four Timespan L PortfoliosTM, which stretch from the near-term to the long-term. I find this approach useful in contrast to almost all of the popular commentators, who appear to be focused only on periods of under twelve months. To use a military analogy, this is like firing a single rocket compared to a longer range guided missile with bigger and multiple payloads.
For long-term accounts, let’s compare an index-tracking ETF with a fully discretionary managed fund. The index tracking portfolio is like a rocket that once fired can not be re-directed to new and better targets of opportunity. The managed account can shift its portfolio composition to address a new or different investment opportunity. It can change its risks assumptions. As a matter of fact that is one of the reasons managed funds have underperformed since 1987 and particularly since 2008; because of fears that periodic down markets would bring on the need for cash to meet redemptions, which has happened to US domestic-oriented funds for more than a year.
Managed Funds Out-performed Indices During Turmoil
Recently S&P/Dow Jones Indices, a subsidiary of McGraw-Hill Financial reported that relatively few mutual funds beat the various indices, regardless of whether that was their goal. In an article in FT Money, Merrryn Somerset Webb of MoneyWeek pointed out that many fund averages lost less than the security averages from April 13th through August 24th. Her astute comment was not that the funds did better, but that the indices did worse. I would suggest that the absence of cash explains much of the sub-par performance of the indices.