Portfolio Construction - Part 11

In a separate piece Price also analyses how the portfolio construction market came to be where it is today, which he characterises as 3 camps:
1) Cost-savers - the rise of indexation, which have now developed into exchange-traded funds
2) Absolute asset managers who eschew benchmarking in favour of generating pure absolute returns
3) Compromisers - closet-trackers caught in the middle, resolutely hugging the benchmark, plus or minus a percentage point or two, but charging active fees and thus dooming their unit holders to underperformance.
He then does an excellent job of separating fact from fiction:
“The supposition of late has been that the extraordinary capital inflows into hedge funds and private equity have permanently compressed their returns. This supposition is wrong for at least two reasons.
“One: hedge funds and private equity per se do not represent one distinct asset class, but rather an alternative philosophy on the management of risk capital that embraces an alignment of manager and investor interests, the varying use of leverage and to an extent a steely commitment to contrarianism.
“Two: while it may well be the case that ‘average’ returns are dragged down by competition, the entire raison d’etre of so called alternative asset management is the belief that exceptional people can deliver exceptional returns on a sustained basis irrespective of broader market conditions. The recent Gadarene flood of variously clever money into the sector may well compress returns for ‘noise players’, but part of the problem given the well-flagged opaqueness allied to these sectors is the huge dispersion in returns between top and bottom decile managers. A more crowded pond does not automatically extinguish prospects of life, but it does raise the requirement to conduct appropriate due diligence on those players most likely to thrive.
“Working in investment in 2007 feels like being part of a gigantic science project. Two almost contradictory styles (traditional and so-called alternative) are duking it out while more passive low-cost providers dart and nibble at them from the periphery. On the evidence of capital flows to date, the traditional managers are under siege, and possibly being kept afloat only by savvy marketing skills (not a trait one can realistically associate with alternative managers since the regulators essentially prohibit it) and a generally supine investment media. But it is difficult to remember the last time traditional fund managers made the headlines - except to jump ship to boutiques, or to take themselves private in some other form.”
So you might not be able to buy into Swensen’s Yale Endowment, but you can do yourself a favour and ditch the ‘compromisers’ kept afloat by brand recognition and by marketing and not by performance and permit yourself access to the private international investor’s equivalent in the form of Scott Campbell and Martin Gray’s MitonOptimal portfolios.
Look at Kidder-Peabody’s nifty-fifty stocks that until just over 30 years ago were de rigeur and look at just how quickly the power balance has shifted. Long only was the best stock methodology before Jones famously popularised long/short but somehow that inefficient approach has stayed the course because of the self-interest of ‘The Street’ and the lethargy of regulators.
We’ll move on to taking a look at how you should look to approach portfolio construction and then we’ll spend some more time puncturing the myth of buy, hold and prosper (or the lazy way to build portfolios and collect fees for doing nothing as practised by far too much of the retail investment industry).
We have looked at why you shouldn’t buy and hold - why certain asset classes are right at certain times but wrong at others. Equity holdings within the portfolios are at higher levels when conditions appear to be conducive to equities and lower when the opportunity for return appears lower or when equity risk premium is higher. That may sound obvious but adopting a strategy like that and actually implementing it in a way that adds Alpha is achieved by less than 1% of investment strategies out there.
However, there is obviously more to it than just increasing or decreasing allocations - there are also style weightings. Within MitonOptimal, two of lead managers specialise in slightly different types of trade. Scott Campbell’s Core Diversified approach generally tends to invest on a ‘what if?’ basis - i.e., when it makes the allocation it also looks at how this can be hedged in the unlikely event that something goes wrong.
Martin Gray on the other hand tends to make more of a commitment trade - if there are strong enough reasons to believe that a market will move up or down then you access that market in the way that gives the greatest upside - maybe not via the best performing vehicle throughout the cycle BUT instead via the best performing vehicle through the part of the cycle that you’re now in - the upside part.
As a result Martin tends to achieve higher returns, Scott tends towards lower volatility. We utilise whichever approach we’re most comfortable with at a given time - clear blue skies would be Martin, a few clouds on a sunny day would be a combination of both, glorious weather but rain forecast would be Scott. As a result of this there are very few equity funds that we would buy and hold indefinitely. While the equity sub-cycle might typically last six years or so, there’d be a number of adjustments within that time - selling highs, buying dips, re-balancing focus etc - after all, this is active management. In each case it’s about buying right and selling right, which is the part of the equation that most investors seem to find hardest.
To be continued…

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]@mbmg-international.com.com

Snap Shots: by Harry Flashman

Nocturnal neon shoots

I walked down Walking Street the other evening with a tourist and he was looking in wonder at the veritable forest of neon signs, and began to take photographs. Fortunately, this was digital, so he could see immediately whether he was actually getting the picture he wanted.
Initially the camera suggested exposure settings that were way off the beam. The reason for that is simple, as he was attempting to get the neon sign, which was taking up around one quarter of the frame, with the surround being inky blackness. Needless to say, the electronic brain was a bit baffled by all this and the signs were totally overexposed, with the camera trying to turn black night into 18 percent grey.
The first change was to get him to turn off the in-camera flash as that was also confusing the issue. The second item was to zoom in on the signs of choice, so that the electronics had something it could handle. Finally we were getting somewhere!
You have to remember that neon is universal, and unfortunately universally misunderstood by most photographers. With a spitting flash, the auto-focus camera grinds away, but when the traveller gets his prints back, he or she is going to be very disappointed. That huge neon glow comes out as a thin thready coloured tube and nothing like what they saw that night.
The failure to record neon lighting was because the photographer believed the auto camera’s suggestion that since it was night, flash must be used. In fact, most auto cameras these days will automatically get the flash ready by sundown. This, unfortunately, is where the modern cameras are just too smart for themselves. A flash is the last thing you need when taking neon lights. The reason for this is quite simple - the strong white flash burst totally overpowers the weaker neon illumination and washes out all the pretty colours (the reason you wanted to take the shot in the first place!).
So, first turn the flash off. Make the neon sign supply the illumination. So what shutter speed and aperture settings should you use? If you have an auto setting on the camera, or you are using a fully automatic point and shooter then you are already set up. No fancy calculations are required. The camera’s meter will do it all for you, provided the neon is full frame. For once, I am happy to let the electronic brain do its thing (but without the flash).
If you want to get technical and do it all manually, then meter from the neon glow itself and then shoot not only at that setting, but also from one stop below and one stop above. This the pros call “bracketing” and it just simply increases your chances of getting a good shot. In the photography bizz, a pro must come back with the goods - no excuses are acceptable! Not even torrential rain, or polar bears out without a leash.
Now, to really go to town with the neon sign effects, get out your filters. If you have a soft focus one, then put it on for a couple of shots. Another interesting variant is to tightly stretch a nylon stocking over the lens. The result here will be a “halo” around the neon and can make for a very attractive photograph. Try putting a “starburst” or a rainbow filter on too. Just to get something different.
And looking for something really different? Another great visual effect is to put the camera on the tripod and use a zoom lens. Select a shutter speed of around ten seconds and slowly “zoom” in or away from the neon light while the shutter is open. You will get something very different with this technique. Something like a 3D movement effect.
Try some neon shots this weekend - just remember to turn the flash off and fill the frame!

Modern Medicine: by Dr. Iain Corness, Consultant

If you don’t eat your meat - you can’t have any pudding! (Pink Floyd)

What we eat is something that has fascinated us for centuries. We have made rituals and even fetishes out of eating and drinking, and the oldest gourmet group in the world, the Chaine des Rotisseurs, is still going and began in 1248 AD. That’s a long lunch!
These days, with our tentative forays into ‘real’ science, our dietary habits have also been scrutinized plus the many claims made for modifying the kind of food we eat and what we drink. This in turn, has produced legions of people who swear by various foods which will cure everything from falling hair to falling arches (or even falling stock markets)!
Of course, it is very difficult to ‘prove’ that by taking Vietnamese ground nut leaves or similar items, ‘something’ (usually cancer) does not happen. Even more outrageous are the claims that some herb, poppy or whatnot can actually ‘cure’ cancers. Is it all just poppycock?
To be able to prove these claims needs medical science to look at a large group, or population, and compare its cancer experience with another similar large group or population. Ideally, the two groups are matched for age/sex/ethnicity/working environment, location, etc. You get no worthwhile results comparing Welsh coalminers with sub-Saharan Africans, for example, to go to extremes.
Finally, some results of a 15+ year study in Australia have been presented at the CSIRO Prospects for Cancer Prevention Symposium. The findings emerged from the Cancer Council’s Melbourne Collaborative Cohort Study, an ongoing research project involving 42,000 Australians who have been monitored since 1990.
Looking at the dietary habits and the cancer connection, Dr Peter Clifton, director of the CSIRO’’s Nutrition Clinic, said there was “zero evidence” that eating fruit and vegetables could protect against cancer. The nutritionists and the healthy eating proponents were shattered. However, this to me is a much more compelling argument than something that comes from folklore, or the lady next door who swears by it.
What the survey did show was that the three prime risk factors as far as predicting cancers were concerned were identified as obesity, drinking too much alcohol and smoking.
More than that, staying within a healthy body weight range was found to be more important than following particular nutritional guidelines. This means a thin person who does not eat enough fruit and vegetables would have a lower risk of developing cancer than someone who is overweight but eats the recommended daily amount of fruit and five colors of vegetables.
Professor Dallas English, of the Cancer Council of Victoria, told the symposium that despite decades of research, there was no convincing evidence on how modifying one’s diet would reduce the risk of cancer.
“The most important thing about diet is limiting energy (kilojoule) intake so people don’t become overweight or obese, because this has emerged as a risk factor for a number of cancers, including breast, prostate, bowel and endometrial (uterus),” he said.
The link between eating red meat and bowel cancer was “weak” and the Cancer Council supported guidelines advising people to eat red meat three or four times a week, Professor English said.
In Australia, the biggest killer is still heart disease, so healthy eating will lower one’s chances of heart disease, even if it does not protect you against cancer.
Both Professor English and Dr. Clifton predict an increase in the incidence of cancer as a result of Australia’s obesity epidemic, but say exercise can play a vital role in cutting cancer rates, potentially halving the risk of some cancers. That I find a rather sweeping claim, but there is no doubt in my mind that moderate exercise is good for you.
So there you are - get down to a healthy weight and exercise regularly, drink alcohol in moderation only (Australians do not know what “moderation” means) and stop smoking. In this way you will lower your chances of heart disease and cancer.
Goodness me, you might even outlive your doctor!

Learn to Live to Learn: with Andrew Watson

The Longest Day

The longest day dawned with a distinct chill in the air. It was as if the long hot summer had run out of steam and was ready and willing to relinquish her place to frosty autumnal mornings. The scent was citrus with pine. As we clambered down from our romantically uncomfortable nest for the last time, emerging from apple crates piled fifty feet high, the grass was swimming in dew and cold to the touch of our shoeless feet. It sent a shiver through our bodies and our souls, united for eternity.
We didn’t talk. We just walked. The only sounds were morning larks singing as they cut across a naked sky, emerging into blueness and cockerels, trumpeting their preposterous fanfare. We walked east across an everlasting lawn, stretching like a deep green sea between bungalows, where people still slept. We were the only ones awake. It felt ephemeral, moving unnoticed like ghosts in a silent world. It felt as if we were invisible and that was just fine. We didn’t need anybody else. We didn’t want anybody else. We only wanted each other. We were squeezing every drop of joy from our last moments together, savouring every single second of touch, every smile and every kiss.
We had talked long into the September night about what had passed and what was still to come. In retrospect I am amazed that two teenagers from utterly different corners of the globe could have understood their future together so intuitively. If we had ever confided to our parents what we presumed to know, doubtless they would have declared the possibility of our union impossible! I was from an undeniably white, middle class English background, the second of four sons born to two successful doctors, attending private school in London. I hadn’t ever really wanted for anything. Sharona was the second of four daughters born to Yemenite Jewish refugees, who had been airlifted to Israel in the 1950’s as part of ‘Operation Magic Carpet’. They were part of an exodus of Jews expelled from neighbouring Arab states in response to the creation and survival of the State of Israel. Her parents came from Sana’a, where nothing had really changed for centuries. On to the plane with them they brought everything they owned, which wasn’t very much; goats, sheep, chickens. When it was time to eat on the plane, they tried to start a fire because they (naturally) wanted their food cooked.
Arriving in Israel, they were the poorest of the poor and ground out a meagre existence from the coastal plain around Rishon Letzion, south of Tel Aviv. At the age of eleven, of her own volition, Sharona had left her family behind to come to the Kibbutz, displaying an enchanting, independent confidence which radiated through everything that she said and did. Indeed, she was hypnotic.
We ate breakfast together in the communal dining room. On their way to the orchards, friends came to bid farewell; the Kibbutzniks were used to the traffic of volunteers, changing shifts every couple of months, but I sensed an enduring bond of comradeship as I hugged them goodbye. I knew I would be back, I just couldn’t say when.
Suddenly, the reality of my imminent departure hit me; I felt like I had fallen into any icy bath and I was being sucked under. I froze, then panicked. All the things I thought I had already said were lost and I was terrified of what I was leaving behind. As the clock ticked around to eight o’clock, my mouth was dry. Facing this perfect vision looking back at me, I managed to steady myself; “I will come back, I promise” I whispered. Her eyes fell momentarily and I sensed my heart, with all its hopes, falling into an abyss. She lifted those rich, round umber eyes, which glistened with tears; “Nobody ever comes back,” she cried. I held her hands tighter. What had happened? Was it all a dream? Were we blind, foolish lovers, duped, consigned as tragic players to a different script? But it had all seemed so simple. Together, we had made our bond with eternity and there was nothing we could do about it! “Give me a locket of your hair,” I implored her, “that I might keep with me always and remember you by…”
A spiral of sweet, soft, black locks, bleached by the sun, scented by the perfume of her soul, lay in my hands and it appeared that all was well again. The sound of a bus could be heard in the distance. Time was short, too short. We walked slowly together towards the bus stop, thoroughly unprepared for the shock of parting that awaited us. We hugged for an age which seemed like a second and kissed longingly, lovingly, for the last time. I took her taste with me and our melancholy gaze held.
From the back seat I watched her, motionless, drift into the distance and then with the roar of an engine and the unkind suddenness of a bend, she was gone. Tears were streaming down my face. She was gone. I could hardly breathe. I smelled her hair and closed my eyes, as I would do many times over the next eight years and she was with me again.
Through my tears, the rumbling, rolling rhythm of the bus finally rocked me to sleep. We travelled for ten hours that day and I was incapable of uttering a single syllable. My companion saw and understood my pain. Arriving at dusk in the dusty, windswept desert town of Be’er Sheva, I was utterly devastated, empty, lost. The last two months were the happiest I had ever been and every thought was of Sharona, the loveliest girl I had ever seen. As I cried myself to sleep at the end of the longest day of my life, somewhere within me I knew that one day, although I knew not when, I would keep my promise and I would see her again.
Next week: A Promise Kept