Structurally Sound: A Timeless Approach For The 21st Century

As I wrote last issue, "the factors that must be accounted for while structuring financial affairs are much more complicated than ever before."

Given that 400- to 500-point swings in the Dow have nearly become the norm rather than the exception, this is ringing even truer today than it did a quarter or two ago. In the previous issue, I outlined the structural and emotional changes that we suspect have primed the markets for their current volatile behavior. I also promised to bring a few ideas for how to keep your wits about you amidst the chaos, so here goes:

1. Give lots of thought and analysis to strategic asset allocation. Many studies show that the preponderance of investment return comes from asset classes you are in for the long pull. It makes sense. If you were in CDs for the past 30 years, your returns were different than if you were in a private business, real estate, or the stock market. Have a solid grasp of what you want and need your funds to do for you. Money you are investing for retirement in 20 years should be in different vehicles than money you need for your child's tuition in the fall of 2012. End uses should dictate what types of investment buckets you can and should consider. But (and this is big)...
2. Pay attention to tactical asset allocation. Blindly assuming which buckets should be targeted and then slapping on percentage ranges with no eye toward the valuation of a specific asset class can do as much harm as help in the long run. For some perspective, think tech stocks in 1999 or financial stocks in 2007. These are the shifts that can probably provide the biggest boost or detriment to your overall progress. Often this entails adopting a contrarian stance. Stocks aren't always the riskiest asset class (think valuations in March 2009 or at the bottom in 1987). Nor are bonds always the safest (think the negative yields of late 2008 or the volatility witnessed recently in even a five-year Treasury note).
3. Look for a well-reasoned, soundly developed process that will stand the test of time and market/economic cycles. This goes for analyzing individual companies as well as potential mutual funds or money managers. Buying investments is not like buying lottery tickets, for example, and CNBC should not be driving your decision-making process. In fact, CNBC can often be viewed as the infomercial of the investment world. The market's day-to-day gyrations are often more reflective of emotions run wild than they are a testament to fundamentals.
4. The starting valuation is a critical variable. This ties closely to having a firm grip on the intrinsic value of the asset or manager you're contemplating for selection. It often entails analysis of cash flow, compensation structure, fees, and incentives. Do CEOs and senior managers have substantial stakes in the company they are overseeing? Does a portfolio manager have their net worth in the fund(s) they run? It's vital to consider if the price you are paying leaves room for things to go wrong, a "margin for error." And it's also important to understand and adjust for factors such as illiquidity and high performance fees. Wall Street has gotten very creative about generating "product" and taking a piece of the action on both sides of a transaction. Keep the analysis as simple and basic as you can. Where are the fees? Where are the cash flows? Where are the incentives and the motivation? Just because it's the latest and greatest synthetic vehicle doesn't mean it's being crafted to serve your risk management or return needs.

Our day-to-day world is rife with a wider range of potential events than perhaps at any time in investing history. Compounding this situation are a bigger selection of vehicles to participate in and an expanded "sandbox" in which to find them (i.e., global versus local investing). The temptation to shut down and do nothing, or to manically chase what everyone else is doing, can feel overwhelming. However, paying attention to some of the basics from those "good old days" just might be the ticket to preserving your sanity and your financial wherewithal.

Carol M. Clark, CFA, is a partner and investment principal of Lowry Hill, a private asset management firm that provides proprietary investment management and financial services to families, individuals, and foundations with wealth greater than $10 million. The firm manages approximately $5.2 billion in assets for nearly 300 families and 58 foundations from offices in Chicago, Minneapolis, Naples, Fla., and Scottsdale, Ariz. She welcomes questions and comments at cclark@lowryhill.com.