From the Blogosphere
Hedge Funds or Asset Allocation - What Does Work?
I know I have just thrown all the popular and widely held investment techniques of the last 20 years under the bus
Jul. 18, 2009 09:30 PM
While tracking the market today, I expanded the S & P 500 graph time window from the normal mode of a month or a year, to run from 1970 through the present. What I found illustrates a fascinating principle of wealth building.
The blue line represents that value of the S&P 500 index. I overlaid the bright pink line to show what would have been the normal path of the economy had the trend from 1975 to 1995 persisted. Obviously it did not.
The period from 1995 to the present represents a time of unprecedented “activity”. What we can also see is that activity produced no sustainable, wide spread, wealth as right now the index has returned to its normal path.
Considering this period from 1995 to 2009 carefully it occurred to me that this “unprecedented activity” brought about sweeping change 1) In the widespread use of hedge funds, 2) Ridiculously easy credit, 3) An increasing population of new market participants (401k investors), and 4) The ascendancy of asset allocation from theory to gospel. As we can see from the graph, none of these changes produced any lasting wealth. In other words, every benefit purported to be true of these changes has been LOST.
Let’s talk briefly about each:
When investing in a hedge fund one becomes a minority partner in a business – a business that makes investments. Just like any other minority partner in any other business, you are at the whim of the general partner and the other partners. So when your other partners determine that they want their money back, you are forced to sell at a loss. This is exactly what has happened to large numbers of hedge funds. Many have evaporated – LOST. Interestingly enough, you could have owned the exact same investments as the hedge fund and you would still have assets today. Yes the price of the investment would be down, but you’d still have something left and you would have an upside going forward.
Borrowing with no accountability removes discipline from the investment process.
“Can we make money on the project/investment?”
“Heck, I don’t know, who cares, the bank wants to give us money. How often does that happen?”
But discipline is how money is made. You have to know WHAT and WHEN to BUY and WHEN to SELL. The easy money always comes too late in the cycle and by that time (when many are buying) it’s too late to buy (exactly the time you’re buying and the time you should be selling). LOST.
No one has taught these folks the real facts about investing. They pick a mutual fund that has the highest rate of historic return or invest in their company stock. They invest with the mindset that this account will have a growth trajectory of an interest bearing savings account, but on steroids. They’re not prepared for price changes and they have been taught that volatility in the market is risk, which makes it bad. When market upheaval occurs, they sell too late, creating permanent losses.
In truth, volatility in market prices in an opportunity and so these folks are constantly on the wrong side of the cycle, loosing money each time they trade. LOST.
Asset allocation says that it matters not what specific security you buy so long as you are in the right sectors and asset classes. This is crap.
The most scorned sector of the economy has historically been the railroad industry. Yet when you look at the returns over 70 years, it’s the railroad industry that has produced the best returns. Curiously, the average life span of an investing American is slightly more than 70 years.
Imagine yourself wanting to buy a business or businesses. I am quite confident that you would do one of two things – 1) buy assets from a failed/failing business for little or nothing, or 2) Find the best business you possible could and negotiate the best deal purchase price. You wouldn’t buy an “asset class” or a “sector”. Curiously, when you look at the Forbes 400 List of wealthiest Americans – no one made their money in “asset allocation”. They all made their money, or trace their money back in one form or another, to a well run business.
The great promise of asset allocation was that it would limit what is incorrectly, though very easily called risk – price volatility. It didn’t. All asset classes and sectors have suffered over the last 18 months and asset allocation has lost more than most, because this method requires international investment which has done even more poorly than domestic. LOST.
What Does Work?
I know I have just thrown all the popular and widely held investment techniques of the last 20 years under the bus. Now here is what works.
Invest in companies that have an enduring product, are conservative financed, and are managed with wisdom and integrity. Buy the shares of these companies when no one else will; when every one is too scared to turn around. “This is when the money is made”. You’ll have as partners Warren Buffett and John Templeton – two investors who have irrefutably created and SUSTAINED wealth for themselves and for others.
Would you like to help your own portfolio? Tell your friends and business associates about this piece. When the masses invest wisely over long periods of time, it helps everybody.
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