Pinnacle Advisory Group grew up on Strategic Asset Allocation and practiced it successfully for the first ten of its twenty years in business. And why not? We all grew up on Strategic Asset Allocation. During the 1980s and 1990s, we enjoyed the endorsement of Nobel Laureates and rode the back of the secular bull market in stocks and bonds.
A Crisis of Faith
But like so many of the advisors we have been talking to over the last few years, eventually there came a day when we realized that Strategic Asset Allocation did not do enough to manage risk especially during bear markets. Our day came following the tech bust at the turn of the millennium. We lost money like everyone else. Fortunately, we lost much less because we did not get carried away with the tech bubble and our diversification discipline worked.
While some might suggest that our results proved the effectiveness of strategic asset allocation, it became clear to us that no matter how you spin it, losing money for clients is a “clear and present danger” to our business. The reason is simple: regardless of the time and effort invested in educating clients on the merits of Modern Portfolio Theory and the relative success of our performance, we know that on some level, clients will always compare your performance to cash in down markets. Which begs the question, will my clients stay with me when I have lost them money? And if they stay with me this time, will they stay with me next time when Strategic Asset Allocation will assuredly lose them money again in the next bear market cycle?
So we asked the simple question in 2001 that so many other advisors began to ask following the 2008/2009 crisis, isn’t there a better way to manage risk? Perhaps it’s too much to ask to avoid losses altogether, but we thought there must be a more effective way to reduce volatility and downside capture. If we could find a solution, we could serve our current clients better and we could offer prospective clients a much more compelling story.
Like any other advisor, we liked our clients and wanted to do well by them. And like any other business owner, our goal was to hold onto client assets. So the marching orders given to Ken Solow from his partners as he embarked on this project in 2002 were “Don’t Screw Up!”
So rather than set-out to become star money managers, Ken set out to develop a repeatable process that reduced as many risks as possible. The goal was to participate in markets when they are rising while always seeking to avoid risk. If we could do that, we would reduce downside capture and compound returns more consistently over time.
Our answer was to build a risk-managed tactical investment program ourselves. After considerable research and due diligence, we decided that by adding a second cardinal rule “don’t own over-valued assets” to the first “own a diversified portfolio of non-correlated assets” we could improve outcomes. In other words, we believed that there were a sufficient number of asset classes and securities within each asset class across the globe to build a diversified portfolio of non-correlated assets without owning over-valued assets for the sake of “checking the style box”. Indeed, we are all familiar with the academic research that shows that owning over-valued assets produces lower returns over time and that owning under-valued assets produces better than average returns over time.
It’s been more than a decade since we made that fateful decision and we are fortunate to report that was absolutely the right decision! The firm now boasts a ten-plus year GIPS compliant and third party audited track record of beating the benchmark with less risk net of all investment expenses and our management fee. Clients have experienced less volatility and we have had a better story to tell – especially through the 2008/2009 financial crisis.
Crisis of Faith at Large
Our Crisis of Faith came early. For others it came following the 2008/2009 financial crisis. And if not by then, then following the European Financial crisis during the summer of 2011. By then, even the most ardent supports of passive, buy-and-hold strategies began to question its effectiveness and started to search for something with better risk management. Ideology gave way to the practical reality that these roller coaster rides may eventually drive clients away.
Working through the Alternatives
Fortunately, we found the solution most appropriate for our practice. Our answer may or may not suit your practice. But the decision is very much the same. We have therefore decided to share our journey with you in the next series of blog posts in the hopes that it helps clarify your own decision process. Then we plan to work through a series of “Due Diligence” posts that highlight some of the things you should be looking for (good and bad) when selecting a final solution.
The slower summer months are an ideal time to work through these types of decisions/projects. We hope you find this new series helpful. And, of course, you should always feel free to call. We are happy to help.