FCVA Home

Back 1 Page

How We Work

Resources for Clients

Videos

Client Map

What You
Need

When You
Need It.

Portfolio Management

Before actually undertaking activities relating to portfolio management, it is worth pausing to reflect on the purpose of portfolios in the first place. What difference do portfolios make and why? One of the best answers to that question comes from Bernstein Investment Research and Management with the unusual but perceptive title of Sleeping With The Enemy, as updated by Harnessing Low Correlations. The more recent article is sub-titled, "The fundamental things apply as time goes by," so read them both, if only for the titles! We felt the articles were important enough to summarize their main points in What Matters With Portfolios. We commend both to your attention.

"You win some, you lose some, but asset allocation beats 'em all."

- James Picerno

"Don't put all of your eggs in one basket" and "When one investment zigs, the other zags" may sound trivial, but both expressions go to the heart of what portfolio diversification is all about. The wise investor knows what he doesn't know, and the future is certainly one of those unknowns. Diversification is the most important step to take when you acknowledge that you really don't know what is going to happen next.

Today's Markets

©2003MorningstarIncAll Rights Res'd.

Bernstein Investment Research and Management has written a series of articles focused on the benefits of diversification within a portfolio. The articles are among the best we have read and are highly recommended: Sleeping With The Enemy, Fortune & Misfortune, etc., Escaping the Dangers of Risk Drag, Role of Faith in Investing, Strategy and Tactics in Style Investing and So You've Got Style: Manage It!. Also read Roger Gibson's classic Rewards of Multiple Asset Class Investing.

It's not only what you hold but also where you hold 'em that is critical to investment success. Asset location aimed at making the best use of tax advantaged accounts is almost as important as asset allocation, as covered in Optimal Asset Location and Asset Location For Retirement. 

How different asset classes relate to each other over time is captured by a statistical measure called correlation. Unfortunately, these relationships change over time as pointed out in The Volatility of Correlation.

What does life insurance have to do with portfolio management and asset allocation? A lot, actually, as an academic paper Human Capital, Asset Allocation and Life Insurance addresses. There's a lot of math, but the paper is worth skimming at least for a unique perspective on asset allocation.

Does it pay to try to pick stocks, or does it make more sense to stick with broad market segments represented by indexes. The debate rages, and there is a lot at stake. A recent academic study makes an interesting, but limited, case for active management in general and for mutual funds in particular. Please note that we do not necessarily agree.

An offshoot of the divide between active and passive investment management has been to build the center, or "core," of a portfolio around passively managed funds designed to achieve market, or asset class, exposure, accompanied by a cluster of additional, or "satellite," actively managed funds aimed at capturing the security selection and market timing skills of those active managers. You might recognize the core and satellite approach to portfolio management as a variant of the "beta" vs. "alpha" theme of modern portfolio theory. Adapted initially by large institutions, the core and satellite portfolio structure is being increasingly recommended to individual investors.

The traditional, and still most common, execution of the core and satellite portfolio strategy involves placing the bulk of the portfolio in low cost, easily identifiable index funds while allocating the remainder to the pursuit of the more elusive and expensive successful active managers. Satellite of Beta makes the case for turning the strategy completely around.

Portable Alpha

The "latest and greatest thing" in institutional investing, for which we will add a number of explanatory articles, is still very much applicable to individual investors as the respected financial journalist Jonathan Clements points out in Some Alphas and Betas of Personal Investments, and also described in Alpha-Betting from Worth magazine.

Remember, the investor can do nothing to alter the risk of an individual investment. It is only by combining investments into a portfolio that investment risk can be controlled. The effective management of risk is the dominant theme in contemporary institutional investing. Large financial institutions spend a lot of time and money thinking about risk and how to manage it, as this recent survey reveals.

Institutions have been hedging their bets made in the face of an uncertain future for years now, using what are called Event Derivatives that pay off in the face of adverse circumstances, such as sharp increases in fuel prices, spikes in interest rates, even bad weather! Individuals have not had an opportunity to protect themselves until now. A California Internet exchange Hedge Street offers the first mass market "retail" exchange for Event Derivatives. A number of articles more fully explain how the exchange works and what it offers. Keep in mind the difference between hedging and speculating. We have placed the link under the heading of risk management to stress our perspective.