Yesterday I was re-reading Capital Ideas: The Improbable Origins of Modern Wall Street by Peter Bernstein. For anyone that has not read this book lately, I strongly recommend it as an exceptional overview of how capital market theory, as we know it, has evolved over the past 100 years.
From the 50's to the 70's Bernstein worked as a portfolio manager at the investment counsel firm his father had founded in the 30's. During his first 20 years in practice, markets enjoyed a strong bull cycle a little like the more recent cycle of 1982–1999. Then came the Bear of 1973–1974, where “the entire rise in stock prices since 1954 had been erased. At the same time, the bond market, the traditional haven of the risk-adverse suffered a 35 percent loss of purchasing power.” (p.3)
Many industry advisors who had only known the previous 20 years of market experience were completely shocked by the extent of the capital devastation done. They had read about previous crashes in market history of course, but somehow the unusually long period of economic prosperity in the 50's and 60's had convinced most that times were much safer and that such large market losses were the things of a distant past. When the Bear of 1973–1974 hit many, Bernstein included, left investment management, horrified by how few risk controls they had actually had in place to protect their clients. As we have witnessed throughout human history, periods of smooth sailing do not build the best sailors.
I was one of 4 on an expert “voice of experience” panel yesterday at a conference on indexing and ETFs. The other 3 panellists were all explaining how they use passive ETFs since clients are looking for lower fee structures. I agree with this premise for picking index units over individual stocks as we also use ETFs in practice for our equity tool. But it really struck me that so much of what we as a profession or business “know” about risk management has come to us from the world of theory and the infinite time horizons of institutional pensions and foundations, and in particular from the Bull market of 1982–1999.
As I write in Juggling Dynamite, people however are not pensions. In other words, this whole idea of no need to time markets or take profits because passive investment in a broad basket or index is the most efficient over 50 year + time frames, is really rather irrelevant to real life people. My clients are all 40, 50, 60, 70. They get the bulk of their capital in lumpy deposits as they sell businesses, or assets, and receive inheritance. Most of their life savings come into being in their last say 10 years of working. So isn't it nuts then that the buy and hold mantra keeps saying no need to time, just invest for the long haul? Most clients don't have 50 years for it to work out and in reality if they lose money over 1 or 2 years in bad markets they are likely to be very psychologically injured by the decline.
The trouble is that investment advice is largely populated by well-meaning salespeople who have really just downloaded a general understanding of investment theory from the academics after the theory has been filtered through a “how to get people to buy” filter from the big firms. The academics are writing about very long term horizons and the “advisors” are sort of blindly applying these “infinite” notions to the “finite” clients they are servicing. And so, little critical thought is going on from anybody about the end user individual investor.
I guess it’s a bit like medical research being performed primarily for one patient group such as white males and then trying to apply those general concepts to other disparate groups without taking into account the unique characteristics of those other patients. The theorists may be right in the institutional large, but the front line advisors are then trying to treat individual patients without accounting for their dramatically different fact sets.
One of the questions yesterday to the panel was: “Is there anything that you worry about, that keeps you up at night sometimes?” All three broker/advisors said no, nothing worried them, and one said he lost sleep over his golf score.
I said that I was a professional worrier. I worry about everything that could go wrong and hurt my clients. As a discretionary, fiduciary manager working for “finite” clients, I believe that my clients pay me to worry about them. Why else would they hire a portfolio manager? Is our job to slap them on the back and take them golfing once in a while? Or is our job to look out for their best interests and take every possible step to protect them from the next big decline?
What keeps me up at night sometimes? I am worried that complacency has set back in. I am worried that after 4 strong market years (where investors have not yet recovered all of their painful losses in the 2000–2002 Bear), investors and their advisors are once again blindly over-exposed to market risk while feebly citing half-understood and misapplied institutional concepts to bolster their courage.
Sometimes I wish I knew less about the risks or could take my fiduciary duty less seriously. I would no doubt get more sleep and play more golf.
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