Introduction
The psychological need
of the investor is a major contributor to the dominant asset allocation
chosen. This is a preliminary, hopefully useful insight in a world of over-simplification.
Further it can be a useful aid in structuring timespan portfolios. For the
moment think of an asset allocation spreadsheet with three psychological
columns and four timespan rows.
The investment account needs to fill in the matrix
below:
TIMESPAN
|
Income
|
Value
|
Growth
|
Now
Operations
Portfolio
|
|
|
|
Intermediate
Term
Replenishment
Portfolio
|
|
|
|
Long-Term
Endowment
Portfolio
|
|
|
|
Longest
Term
Legacy
Portfolio
|
|
|
|
TIMESPAN L Portfolios®
Income
The oldest investment
need is to meet critical expenses. For each investor these may go from the
immediate need to put food on the table to obtaining the most expensive item of
fashion which can be real estate, life style, breakthrough medical care or the
latest gadget. The income need includes the cash generation from capital and
capital itself. Enough income is in the end not a statistic but a feeling of
well being.
The
need for income may be immediate and/or a stream of cash for different
timespans. For example, it may be high immediate expenses or future streams of payments requiring
well covered cash generations. To the extent of long-term payments in a
world of paper or electronic money, the impact of inflation should be
considered as to the value of cash levels.
Most income driven
investors tend to live very much in the present. They view loss of income as
much more serious than a missed opportunity to enhance income and capital
generation. They believe that they are conservative, but often they are taking
into account only what is present and not the value of current and future
income.
At prevailing interest
rates on presumed high quality fixed income paper, investors are being pressed
to meet perceived payment needs. This is particularly true for US foundations
with a tax requirement payout of 5% over time. Currently, in most cases income
investors are ignoring the present but low level of inflation. This is reducing
the real value of both the spending and capital base.
Our preferred solution
is to invest in established companies that have a long history of growing well
protected dividends in good times and bad. Currently there are a number of
these in the financial services field which we can discuss offline. In these cases I believe the
income is secure and generally grows faster than normal inflation. The risk is
in the fluctuation of the price of the shares. In many existing cases they are
reasonably priced in terms of their intermediate- term outlook.
Value
Value investors really
don't like making meaningful mistakes. Perhaps earlier in the investment
experience they were exposed to big mistakes made by others or themselves.
Their reaction to prevent future mistakes is to accept a well defined price discipline.
They will often quote the two big investment rules: Rule 1: Don't lose money and Rule 2: Don't
forget Rule 1. This is the historic coda from my old professor David Dodd
of Graham & Dodd fame. This strong survival instinct at times prevents them
from buying into big opportunities with substantial risk of loss. They are just
the opposite of successful venture capital investors that have more losers than
winners but the winners are large enough (and then some) to make up for their
losses. Because we live in an uncertain world, most often they own lots of
securities to diversify their risks.
Most of the time they
are attempting to arbitrage the difference between current price and some
standard of value. It is in the selection of this standard of value where the
value investor tribe breaks into sub smaller units or families. Many of
these families use the various corporate accounting statements to
determine their values; e.g., book value, net tangible value, revenues per
share/per customer or net liquidation value. It has been my experience that
often many stocks sell at a 30% discount to their theoretical value. However,
normally this discount is not fully captured quickly without some internal or
external activist event.
In effect the value
investor lives in the current price range and wishes for the market to
relatively quickly recognize the present value. These kinds of investments,
when they work well, are found in the Replenishment Portfolio which invests
through the present cycle. Because of their risk aversion value investors have
better than market performance record, but often underperform when the market
is looking for dramatic changes in the future.
Growth
The growth investor
fundamentally believes in dramatic change that most do not fully comprehend.
The change could be based on technology, radical price movements because of
fundamental and largely permanent supply and demand shifts, as well as substantial and
lasting impacts of demographic evolution. The successful growth investor not only
believes that he or she can spot future changes but also which company can be
the most successful exploiter of these changes. Relative to the value investor
they are more tolerant of near-term price risk because they see larger and
longer-term price rewards. Except for large funds investing in smaller
companies they tend to have more concentrated portfolios. However, they are
much more sensitive to changes on the horizon which makes them less
patient than value investors. Thus often they have more concentrated higher
turnover rate portfolios.
Putting
Income, Value and Growth to Work
In each cell of our
intellectual investment matrix of the three asset allocation types and the four
timespan investment periods, the investor should determine the appropriate mix.
Thus one might have 60% in income, 30% in value and 10% in growth for the Operational Portfolio; 60% in value and 40% in growth for the Replenishment Portfolio and the reverse in the Endowment Portfolio. The Legacy Portfolio
could have 70% in growth and 30% in value. Please note that I do not divide the
world into domestic and international. I believe just about every company and
most individuals are increasingly impacted by activities beyond their national
borders. As indicated in earlier blogs "We are all Global." The
location of incorporation or main securities market is a third level sort
for administrators and sales people to worry about.
Rebalancing
The very next trading
day changes the actual allocation from the planned and prior day. Far too many investment
organizations rebalance mathematically back to an original allocation. I believe
rebalancing is an account-specific responsibility. I am very conscious that
most large successful investors/entrepreneurs have made most of their
money in a few or even one security. I am also aware that a family's
concentrated wealth can be wiped out in a major failure. Thus, I suggest
that rebalancing is a critical decision for the capital owner to make. One can
see the degree of concentration will change as investment control shifts from
the founder to succeeding generations of family workers and non-workers.
Further, to me rebalancing is essentially a market call of quasi permanent
market change or a return to some concept of "normal." The
decision may be heavily influenced on payout considerations from how "income"
and capital are defined.
What
Not to Invest in the Legacy Portfolio
The whole concept of
the Legacy Portfolio is that since the current generation of investment
managers are responsible there are likely to be future periods of disruptive
change compared to the present construct of our investment thinking. Often
we may want to focus on investments that would benefit from expected changes.
It is equally important to focus on what should not be there.
Two possibly negative
trends that should be considered for reduction or elimination in a Legacy
Portfolio are:
1. JPMorgan Chase
I have great respect
for JPMorgan Chase and its CEO Jamie Dimon. Personally I have owned the stock
for many years and it is our main deposit bank. Nevertheless, it should not be
considered in a Legacy Portfolio of companies to benefit from
disruptions. I commend Dimon’s brilliant 46 page letter to shareholders that
describes their success and outlook. It is the bank’s very success under Jamie that
makes me question whether at some future point the stock of JPMorgan Chase may
not be an investment leader. If one links the performance of JPMorgan Chase
from the date of its merger with Bank One its stock was up 211% compared with a gain for the
S&P500 of 154.8% and the S&P Financials 32.3%. For the last ten years the
annual compounded growth was +8.6%, vs. +6.9% for the S&P and -0.4% for the
financials. JP Morgan Chase has been a great stock. In the same period the
large foreign banks have retreated. My fundamental concern is that it is less
likely that the bank's relative performance advantage will continue. I expect
that at some point the global financial businesses will be restructured to
reduce the odds of continued success for the current bank.
2. Urban Real Estate
The second area to
possibly exclude in the Legacy Portfolio is urban real estate. Cities are
absorbing rural populations all over the world for sound economic and
demographic reasons. At some point there will be intolerable overcrowding and
with the advent of the internet and driverless vehicles, some of the people and
capital will migrate to exurbia.
Whether these two
thoughts work out, the key message is to look for those investments that will
be advantaged and disadvantaged in the future.
Your
Thoughts?
_________
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A. Michael
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