Better Portfolios from 14 Questions - Weekly Blog # 503

Better Portfolios from 14 Questions

The initial fourteen questions are:

1.  When will the money be needed?

2.  How would you rank these portfolio drivers:

      a) Economy

      b) Stock Market

      c) Bond Market

      d) Political Swings

      e) Popularity

   

3.  What are the triggers of change anticipated?

4.  How do you define a cash conversion timetable?

5.  How would you structure the replenishment of the Short Duration portfolio?

6.  What are the tolerable levels of Absolute and Relative Risk by TIMESPAN Portfolio?

7.  What is the sustainable spending relative to inflation?

8.  What should be the appropriate performance measures for each TIMESPAN Portfolio?

9.  What allocation or weightings should each TIMESPAN Portfolio receive?

10. What is the client's tolerance for known absolute and relative losses?

In addition, the following need to be determined:
 

11. Governance Procedures

12. Turnover of portfolio 

13. Legacy Requirements

14. Termination Procedures

I would be happy to discuss privately with any of our subscribers if they are having difficulty answering these questions and how the answers might impact their better portfolio construction.

Introduction

Portfolio construction and management is an art form and at worst an alibi for failed results. The way we practice the art form is to recognize that it is an expression of deeply held personal beliefs as well as reactions to client needs vs. desires and current conditions. Structuring each portfolio is a continuing discussion and can encompass aggressive and conservative tendencies which can be executed through individual securities and/or open end mutual funds as well as diversified holding companies.

Diversification & Weighting

Diversification is a method of risk control.  Component weighting provide brakes and accelerators for portfolios. The more difficult tasks are after the initial portfolio construction is in place as market prices shift the relative contribution of each component.

A key determination is what should trigger purposeful changes to the weighting in the portfolio?

One should review the portfolio weightings of the components. This review can be done at regular calendar intervals or as a reaction to expected or actual market conditions. The portfolio weightings will eventually become distorted by performance. Due to the good performance of some of the components they will rise in importance in the portfolio and by that fact alone reduce the importance of other components. Both should be examined closely. 

If only one-third of the big gains can be attributed to operating earnings gains, not published eps gains, the rise in the market prices will be due to perceived valuation changes. If the valuation measures are close to or exceed past record levels, there is increased risk which should be addressed. Any cutback or elimination does not prevent risks returning in full or partially. The more difficult task is when the defensive positions lose enough relative weight due to the bigger gains of the winners or some temporary price declines. If the weights of the defensive positions drop by more than 50%, they may not have sufficient weight to substantially reduce the fall of the entire portfolio when there are periodic market declines. In these cases moving some money out of the winners to the more defensive positions should be considered.

In addition to the 14 listed above, additional questions need to be answered before the investment structures to be used in each portfolio are determined.

Questions for the Short Duration Portfolio

This portfolio’s payments could include all payments, truly an operating expenditure bank. Or it could be used exclusively for short-term emergencies, as a reserve for the unexpected; e.g., repairs, health emergencies, and other unanticipated costs.

One of the most critical question for the Short Duration Portfolio is: how much of this account should be available to convert to cash within one to three days and how much within thirty days?

Questions for the Replenishment/Feeder Portfolio

What is the likely exhaustion date of the account before replenishment? This can be triggered by the minimum value of the account before replenishment and will impact construction of this portfolio.  Also you will need to decide whether replenishment capital will be partial or complete in one transfer. In addition, you will need to establish the level of inflation risk that can be accepted before adjusting replenishment moves.

Questions for the Endowment or Lifetime Account

1. What are the expected governance procedures as the key investment decision maker ages or is no longer competent or alive? 

2. How should the replenishment and short duration portfolios be refunded and will they change their nature over time? 

3. What will be the risk tolerances of absolute/relative losses, inflation losses, and appropriate benchmark measures? The tolerance for risk assumptions moving through various market cycles will frame part of the equation for the long-term success of this account. 

4. What is the expected longevity of this account? 

5. How should the turnover procedures for the final legacy account be determined?

Questions for the Legacy Account

What will control the duration of this account, the exhaustion of the money or people involved in fulfilling a mission? Is it to be thought of as a perpetual account?

Will the Legacy account also need to setup and manage a separate short-term account with its own replenishment device?

Our Investment Approach

Each of these accounts can be managed aggressively or conservatively. Individual securities, both publicly traded and private assets along with open-end mutual funds can be used. 

Each account should reflect the wishes, beliefs, and focus of the capital owner.

Seasons Greetings

Ruth and I wish you a Merry Christmas, a Happy Boxing Day and a Healthy, Wealthy New Year.

A Note to our Email Subscribers

Last week a small number of email subscribers received a fake email from me offering supposed documents to be downloaded from “The Cloud.”  We are taking the following steps to reduce this type of cyber-risk:

1. We are tracking those email addresses targeted by this fake email and other similar phishing.  Please let me know if you receive this type of fake email, BUT PLEASE DO NOT OPEN IT. 

2. Next month we are changing the email delivery system for subscribers who receive the blog with the subject line: “Mike Lipper’s Blog.”  We seek to reduce cyber-risk and to make the blog more convenient to read. We will give you sufficient notice.  

3. Those who receive my blog post’s title as the subject line of their emails from me (“Single Portfolio Cannot Do Multiple Jobs, Weekly Blog # 502”) will not notice a change.

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A. Michael Lipper, CFA

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