Written by Lance
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03 February 2010
We have described our general approach to how we invest money (see here.) Frankly, I am not happy with it. It gets the main points across, but I plan to rewrite it to make it shorter and clearer.
It comes down to paying attention to a lot of things, especially valuation, making considered judgments about what the risks in the various markets are, and identifying the most prudent ways to manage them. We do have a process, but it lacks the formal mathematical precision so many "investment processes" claim, or at least try to appear to be based upon. Interestingly, some of the firms I respect the most are struggling to boil down what they do as well. Ken Solow over at Pinnacle Advisory Group (which also features one of the planning professions shining lights in Michael Kitces) comes clean about their own "process" and says some things that, I think, apply to us as well:
"Of late, for one reason or another, I’ve spent a lot of time describing Pinnacle’s investment process. For the record, the best explanation of our process is that we have a multi-faceted approach to decision making that considers fundamental or traditional valuation analysis, analysis of business and market cycles, as well as technical analysis of investor behavior. This is but another example of why we believe in diversification, although in this case it results not only in portfolios with diversified asset holdings, but a portfolio where decisions are based on more than one kind of analysis.
I’ve written previously in this space that I believe that investors who are interested in active management will first explore the technical method of tactically allocating portfolios. Using technical analysis has many benefits, perhaps the most important of which allows the advisor to develop several “rules” for following favored indicators. These rules then become a quantitative approach to decision making that is relatively simple and relatively effective. Most of the active managers that I’ve reviewed are using some type of quantitative system based on simple trend following or momentum rules – all of which are based on technical investing techniques such as relative strength, oscillators, trend lines, etc. The resulting system becomes a “proprietary decision making process,” a very valuable product to sell to investors. For the record, a proprietary process implies a secretive, valuable, exact, scientific, repeatable process that no one else can duplicate.
At Pinnacle we have also developed a proprietary investment process. It’s called “doing the work.” Unfortunately our process requires us to make qualitative as well as quantitative decisions about asset allocation. And to my knowledge, there is no easy way to make a decision based on the weight of the evidence as determined by our judgment, experience, and expertise. For us it means slogging through the 100-plus economic releases each month to find clues regarding the market cycle, Fed policy, currency direction, etc. It also means reading daily, weekly, and monthly research reports from dozens of brilliant analysts who disagree with each other all of the time. Marrying this process with our own proprietary quantitative approach is nothing but hard work. But it sounds a lot better when we call it our proprietary investment process. For the record, our proprietary process is inexact and messy, but I have a great deal of confidence that it is the lowest risk method for making investment decisions."
I think the last paragraph, especially the last sentence, puts the truth about how the best investment processes really work. Ken and Pinnacle have come a long way in moving beyond the "set the asset allocation and wait as long as necessary" school of investing that dominated our profession for so long and have done a lot of good work since making the change. Of course, we do use some managers with truly proprietary investment processes in order to execute what we do. They have their place in a portfolio, and especially in overvalued markets in the midst of economic environments fraught with risk. For the overall portfolio however, nothing replaces just "doing the work."
The View from the Bluff
