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July 18, 2006

Principle-Driven Portfolio Management

Nick Murray is one of my favorite financial writers. He is an author, speaker and advisor to investment advisors. While I disagree vehemently with the diversified portfolio approach he advocates, I cannot help but agree with most of his views on how to "think about" portfolio management.

 

He publishes a column each month in Financial Advisor magazine, which is unfortunately, not published on their web site. That also means, in order to share any of it with you, I must re-type it or scan it and run it through OCR. I thought the article, "Portfolio Management As Belief System" was so right on target, that I have done that.

 

The subtitle is "Principles, not prognostication, produce superior returns." I could not agree more. The Snider Investment method™ is, as it turns out, a principle-driven approach to portfolio management, not one based on prognostication. Here is an excerpt from the column:

 

Investors should not be seeking the maximum return possible anywhere in the universe, but rather the best return available with the least stress. In this construct, if Investor A gets a 9.5% lifetime return and thereby achieves his goals with the expenditure of little or no time and energy, while Investor B gets 10.7% working on his portfolio nearly every day, Investor A is held to have outperformed by a significant (if not precisely measurable) margin.

 

(This hypothetical comparison is made only to illustrate the idea of a quality-of-life component in real returns. You will not have failed to note that, in actual practice, the above juxtaposition of outcomes could probably not happen, everything else being equal, because the guy "managing" his portfolio every day would have made so many more market-driven portfolio switches that he'd have drilled his return into the ground.

 

The principle-driven portfolio management belief system thus begins with the dictum that "performance" is not a financial goal, and that the only rational basis for the construction and management of a long-term portfolio is the long-term financial goals of its owners. Thus questions like "When will the Fed stop raising rates?" and "What will the S&P 500 earn this year?" are subordinate, by several orders of magnitude, to the questions that really matter: (1)"Who is the money for?" (2)"What is the money for?", and (3)"When will this money be needed?" Or, if you prefer: the portfolio doesn't follow the market; it follows the human needs of the investor household/family.

 

My way of expressing this same belief is "Focus on outcomes rather than numbers." The idea is exactly the same. Obsession with performance is a disease inflicting most investors. A principled, rational approach makes more sense but the medicine is difficult to swallow for most. Here is another excerpt:

 

The third principle in this system states that the dominant determinant of real-life long-term return isn't what the portfolio does; it's what the investor does. That is, investor behavior dwarfs investment performance in determining the actual return that investors get.

 

[...]

 

Of necessity, since most financial input ordinary people receive is from journalism, they are constantly being brainwashed by a selection-and-timing culture. The primacy of asset allocation may be the immutable truth, but it isn't "news", and therefore journalism can't cover it. The truth is not merely different from the news, it is antithetical to it. The news is the disease; the truth-telling principled advisor is, for most investors, the cure ... assuming, of course, that they want to be cured.

 

Again, I have a different way of stating the same principle: "Investors are their own worst enemy." Investors are irrational. Investors emotions cause them to react irrationally - to do the opposite of what they should be doing - to view things as important that aren't and to view things very important as not.

 

Principle-driven portfolio management requires discipline. It also required, as Nick Murray states elsewhere in his article, for you to remain lashed to the mast of your principles in the face of storms of pounding fury. That is hard, for anyone. It is even harder to get others to stay lashed to the mast with you. And yet, we must.

 

So what do you think? Does this idea make sense to you or do you think it is all wet? Let us know. Leave your thoughts and comments below.

 

SOURCE:

 

Nick Murray. "Principle Driven Portfolio Management: Principles, Not Prognostication Produce Superior Returns," Financial Advisor, May 2006; p45, 46 <No on-line version available>

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Posted by Kim Snider on July 18, 2006 | Permalink

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