Introduction
We
are entering the Pivoting Season. Some investors will succeed and others won’t. One
needs to understand both the successful and unsuccessful pivots
in history and at present to be able to pivot successfully in the future.
Current
Pivot Attempts
For
some time the “Jarrett Administration,” otherwise known as the Obama
Government, has been attempting to execute a Pacific Pivot without meaningful success.
Another
pivot is the coming “Brexit” referendum with the base arguments
shifting away from London-oriented economics toward social and
defense concerns. The continent can not progress economically without
Britain, but Britain can survive and even progress without Europe,
albeit with some near-term difficulty. In my humble
opinion, the momentum will be for the UK to leave.
In
the run-up to the US Presidential elections we traditionally enter the period
of pivoting to the center and escaping from the strident extremes. This year, due
to the length of the primary season and the shift away from network news
to the Internet, the movement toward the
center is going to be much
more difficult unless there are surprises.
With
this focus on pivoting it is natural for investors to also think deeply about
pivoting their portfolio into more winning structures. Based on my
study of history and racehorses, my instinct is not to try it unless you use
appropriate, professional talent and then restrict the pivoting to only sections of the portfolio. Our goal is to execute a pivot if certain conditions
are met (such as those passed on from Lincoln to Generals Grant and
Sherman) as described further below.
The
Most Successful Pivot
When
President Abraham Lincoln changed focus from defeating the Confederate armies in battle to winning the war, he picked different leaders
and different battles. He shifted from primarily fighting in Virginia
and Pennsylvania to Missouri and Tennessee. His leadership changed
from generals who graduated at the top of West Point to those at the bottom of the Class; from officers that were accustomed to riding horses to
ones who in Grant’s case, only made a modest living driving mule chains.
Ulysses
S. Grant built his campaign from the shores of the Mississippi River
down through the tough terrain of Missouri through to the western side
of Tennessee. The Confederate high command took this as a continuation
of the North pushing southerly with the ultimate political goal of
seizing the political center in Alabama.
At
this point Grant ordered General Sherman to execute the pivot. Instead
of a north to south-oriented drive, Sherman executed from the west
in his ‘March to the Sea’ (Atlantic Ocean). His target was to knock
out the logistic center of the Atlanta rail head. The battle shifted from political targets to a war-making capability.
Because of the
speed of
execution and the destruction of property along the way, Sherman was
able to survive a two front exposure (from the north and the south) when
the Confederates reacted with underwhelming force. In the end the pivot
brought the US Civil War to an end many years before the old, politically-oriented strategy would have. In terms
of the conditions for a successful
pivot, Lincoln had chosen the right leaders, the right time, and
the right place.
Both
Napoleon and Hitler also made pivots from the west to the east into Russia
and failed miserably because they did not have the same right leaders,
time, and space.
Is
this the Right Time to Pivot?
Are
we at a similar point as was Mr. Lincoln, when the top strategists are wrong? Let’s look at the results this year from the standpoint of large stock
and bond portfolio investors.
High Quality Corporate Bonds and US Treasuries are meant to be risk absorbers
as they no longer can produce income above actuarial assumptions.
They are not meant to be performance
vehicles. The S&P500
has a Corporate Bond index that seeks to replicate components of the S&P500.
Through the first five months of 2016 this bond-only index was
up +4.99%, after being the only major asset class to show positive results
earlier in the year. The problem for
most investors is they didn’t own
enough of this dull instrument during this period because they were not
being advocated by the ‘top of the class strategists.’
What
is even worse is that most large investors owned the wrong stock sectors.
In the five month period ending May 31st, the S&P 500 stock index gained
2.59%. During the same time period the healthcare sector was
down -0.3% and the financials -0.74% of
the stocks within the index.
These two sectors were heavily owned within institutional portfolios
and favored by most strategists. What really hurt the pride of portfolio
managers and the pocketbook of investors is that there were three
large sectors producing double digit returns: Utilities +12.80%, Telecommunication
Services +11.45% and Energy + 10.73%. My guess is
that the first two sectors were only slightly owned by institutional accounts
(with the exception of Verizon and
AT&T which was held for yield).
The third was shorted by the hedge fund
community.
After
a period of disappointment with market and performance leadership,
performance-addicted investors are ready to switch
horses. Should they? Do they currently have the right generals and
right locations?
The
Lessons from the Track
As
my regular readers may know, I have learned many analytical
approaches in attempting to analyze the past performance at
racetracks. I have previously written that there are “Horses for Courses” and more importantly that the changing conditions
of each race should impact the probabilities as to the ultimate results.
There
are other factors that should also be considered. These start with the
racing history of the particular horse and those of its family, including
the sire, the dam, and their families. Plus a similar review is required of the past
success of the jockeys, trainers, and stables. The challenge for both the
track and security investor is that there are very few winning teams that
have a good record under all conditions. Under the pressure of the laws
of economics, most of the better teams are under contract to rich players.
In our investment account world, this often means high-fee hedge
or private funds.
While
we look to find consistently superior teams and horses, they are hard
to find. Thus, we tend to match the available talent to the expected conditions.
Right
Battlefield Locations
One
the first major distinctions a good handicapper or track analyst focuses
on is the length of the race. The length often determines the
racing strategy and betting (or if you prefer, allocation strategy). In short
races opening speed is very important as there is little opportunity to
recover from a slow start. In longer races there is both the opportunity and
risk of recovery. Stamina and the ability to handle change in leadership
becomes important.
It
was the thinking expressed above that was a critical element in our development
of the TIMESPAN L PORTFOLIOS®. In this structure we
divide the portfolio responsibility into at least four different timespans.
The
first or Operational Portfolio is to fund the cash needs for the
next two years. From a manager, fund, or security selection standpoint,
capital risk is paramount.
The
next three of the portfolios should have different representations of investment
styles (growth, GARP and value) and talents (technological, turnaround
and management assessment). This is a real mix and match effort,
which is based on the individual needs of the account.
The
second or Replenishment Portfolio is designed to recapitalize the Operational Portfolio. Often the duration of this portfolio is five years or a capital cycle. From a selector’s viewpoint the cycle is presumed to have
at least one down year and some recovery. In the first two portfolios
liquidity is very important and expensive however is less important
in the final two portfolios.
The
third portfolio (Endowment Portfolio) is designed to meet the longer term
funding needs often tied to the expected
length of service of the CEO, Investment Committee Chair or Chief
Investment Officer. This portfolio
is expected to last through a few cycles and can accept some risk
of loss capital if it has a positive cash flow.
The
final portfolio or Legacy Portfolio is the funding vehicle meant to endure
beyond the current sets of management and is designed to successfully
tolerate a number of disruptions while still provide funding to
meet very long-term needs.
Where
Are The Generals?
In
the US Marines I attained the rank of Captain, however I have devoted
my adult life to studying various generals, both investment as well
as military.
As
a General, U.S. Grant handled numerous setbacks just as a competent securities
selector is able to survive the unexpected and not lock into positions
where there is little prospect of recovery.
Question
of the Month:
Do
you have or want the right generals?
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A.
Michael Lipper, C.F.A.,
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