Courtesy of Capital Bank
By Peter Capozzola, CFA
At our house, I stay away from any projects having anything to do with electricity; or anything that can result in a flooded basement or in a tree crashing through our roof. Sure, I can look up a YouTube video for advice, but for me DIY has its limits. I’m better off hiring someone who has the professional experience and skills in these fields and is hard wired in ways I am not.
When it comes to investing, people can take the DIY approach and even find tutorials on YouTube (you may want to skip past the “Roaring Kitty” GameStop Meme). Beyond that, the advice offered can be like pieces of a puzzle; incomplete, and from which it is impossible to grasp the full picture. Worse, the information may simply not be applicable to your goals and circumstances, so it is not the solid foundation on which you would want and need to build a plan for your future.
Managing investments is what an investment manager does day-in day-out, year-in year-out. It is a profession they are committed to, and this is how they are hard wired. To us, the keys are an informed approach; executing a disciplined process; having the right people on our team; and focusing on capital preservation by striking a balance between risk and reward and seeking a margin of safety when investing.
There are five key elements to a successful client-advisor partnership: an informed plan; an appropriate strategic asset allocation; opportunistic tactical allocation, diversification, and ongoing communication with clients.
What informs an investment plan is not so much the markets or numbers, but what matters to you. Any discussion should include a review of your cash needs, time horizon, tolerance for risk, investment return goal, tax impacts and your unique circumstances. Each of these factors should be considered when determining an appropriate investment path for you.
That investment path begins with a “strategic allocation” that lays out the appropriate mix of cash, bonds and stocks, taking into account the historical returns and risks of the markets over the long run, which is suited to meet your particular goals. Keep in mind that as your circumstances change, your investment path and strategic allocation will likely change as well.
While a strategic allocation approach points you in the general direction, it is not enough on its own; and that is where tactical allocation changes play a role. As an example, in the financial industry, the classic strategic asset allocation is a 60/40 split between stocks and a combination of bonds and cash. Some say, “set it and forget it”; leaving your allocation unchanged regardless of what is happening in the economy or the markets. We don’t see it that way. Instead, we search for opportunities to add value by identifying opportunities to generate returns and also to identify and manage risk in the short-term.
The goal is to navigate through an ever-changing world, economy and markets by identifying consequential forces and changes, their potential impacts on our clients’ investments, and more importantly what it means to achieving their goals.
What happens in the economy flows into the markets and this has consequences on your investments. Proactively repositioning investments on the basis of changing outlooks for opportunity or risk gives you the opportunity to “do something before something is done to you”.
Whatever the state of the economy, inflation, or the markets, there is always an opportunity to realign investments to better suit conditions.
Working hand in hand with tactical allocation is diversification. In tandem, these tools can benefit any investor. We stress the importance of diversification as a risk management tool, one we feel is greatly underappreciated. Diversification is most often described as not having all your eggs in one basket; but it is far more than that. Diversification reduces the chances that your goals and plans will be placed at risk if one single unfortunate event occurs. However, risk can be subtle. An investor could believe themselves to be fully diversified and yet that same investor could find their diversification superficial and still be exposed to the risks of a single event. This can be the case in “thematic investing” where you may own a large number of different investments, but they all share the same theme, characteristic and opportunity and are essentially the same single risk. That is not effective diversification. Appreciating the correlations and characteristics of each investment and your investments as a whole are critical to achieving diversification.
One key goal of any wealth manager is positive “risk adjusted returns.” Boiled down, this means that you got paid for the risks you took. If an advisor gets you a high return but bets the farm to do so, is that what you want? An upfront conversation about your tolerance for risk may say otherwise. An advisor should assess any upside potential with its associated downside potential. Ignoring the downside has a price. Capital preservation and managing downside risk are critical parts of managing clients’ investments and why we focus on what is called the “margin of safety” when investing in common stocks.
Our margin of safety approach is to buy stocks that trade below their Fair Value. Stocks bought at a price below their fair value may be expected to be more resilient to negative news reports than a stock purchased well above its fair value which, if it falls short of expectations, may prove to an uncomfortable experience.
The final piece of a successful client-investment manager relationship is ongoing communication which transforms an initial plan into a continuously informed plan. This is the “wash, rinse, repeat” part of investment management. We encourage regular communication with our clients that may inform us that changes to the overall approach may be needed.
People and process are the bottom line. The relationship between client and the advisor, strengthened by ongoing communication, and adherence to an investment discipline are the keys to a successful partnership.