With my portfolio management rules, one implicit idea is that I am not managing for the near future. The near future is a crowded trade. How is it crowded?
- High frequency traders schnitzel away at the bid-ask.
- Day traders and swing-traders play with chart patterns, and generally follow the trend, perhaps to some advantage on average, or not.
- Quantitative equity managers turn their portfolios over rapidly. What’s the average holding period, three months?
- Mutual fund managers and many institutional equity managers turn their portfolios rapidly. The average holding period may be in the vicinity of ten months.
- Long-short equity hedge funds have short holding periods as well.
- ETF trading tends to be rapid, but how much effect that has on the underlying is less certain.
The Buffetts of the world are rare, where the favored holding period is forever. Marty Whitman also rarely sells. Maybe my mother comes close, with holding periods around a decade, and she has done well over the years.
I set up my methods to get into a less crowded game. When much money plays for the short-run, why not play for the intermediate-term? You don’t have to play for the Buffett-like forever – after all, he is playing a different game as he builds a conglomerate that can likely prosper after his death in most scenarios where the US survives.
Even Buffett did not play for forever when he had less capital; he would do some arbitrage, which was short term. He would buy stocks that he would trade away a few years later. Forever became the mantra as the assets to deploy grew large.
I manage money for a small but growing number of clients. I don’t have the constraints that Buffett does. But I would rather choose a less crowded area in which to compete. Thus I aim for three years out.
Pimco and Value Line
There are others that institutionalize a longer view. I will mention two of the better known in the retail community. Value Line, for its data service does an economic projection 3-5 years out, assuming economic growth and no major wars going on. I often think their projection is too bullish, but the point is to give a common set of factors off of which to base financial projections for the companies that they follow.
As an aside, Value Line as a service has hit hard times largely because the short-cycle aspects of the service that go into the Timeliness Rank are overanalyzed by the market – price momentum, earnings momentum, and earnings surprise. But that doesn’t mean that the data service is useless – where else do you get so much data on a page? Even Buffett uses it.
Pimco does a three-year projection to analyze where the various bond markets and economies will likely be. That feeds into their overall asset allocation across the fixed income asset classes.
My view is that we have to look past the present day, and ask what will things will be like three, maybe five years from now. During times of crisis, ask whether there is a permanent change going on, or one that will likely be fixed. Most problems will likely be fixed, so crises are times to add more cyclicality to the portfolio little by little. Don’t be a barbarian and make bold moves. You could be wrong. But don’t be a ‘fraidy cat and panic, lest you be the one that loses the most.
True structural shifts are rare. Absent war on your home soil, plague, famine, rampant socialism (not seen in the US or Western Europe yet), most change tends to happen gradually, often due to social or technological change. More often than not, the politicians and regulators are behind the curve, reacting slowly to a societal/business environment that has already changed. This applies to emerging markets as well.
So, during a crisis, leg into investments that you think people and businesses will still need 3-5 years from now. In fixed income, think of what cashflow streams might be in demand relative to inflation rates. Think in terms of industry mean-reversion, while avoiding buggy whips like newspapers, bricks and mortar booksellers, fixed-line telephones, etc. Most of the areas I avoid are areas where the internet is collapsing margins of offline businesses.
But when things are running well, think of taking a little off the table, particularly in areas where the economy is running hot. Again, little-by-little – the peak of the credit cycle is not a peak but a mesa, where it may take 2-4 years before the credit bust hits. But, the longer we have been on the mesa, become more aggressively conservative.
Risk Control Done Up Front
Risk control is difficult to do on a spur-of-the-moment basis, when an event has happened, and your stock is down 10% or more. And that’s not to say that I don’t experience events like that on single stocks every now and then. The point is to think ahead now, and minimize the odds that your total portfolio will not be badly positioned for the next three years, taking account of what might go right or wrong, and the approximate odds thereof.
To manage a portfolio in this way is businesslike, like a flexible diversified company that invests in more promising business lines, while selling/reducing capital to business lines that are less promising. It also gives ideas time to develop; mean reversion is typically a 3-5 year process, so allow time for this. Patience in a good idea will be rewarded.