Hi Guys,
Some recent research that focused on a portfolio’s fixed income holdings by financial and retirement planning heavyweights has prompted a reevaluation of the recommended bond percentages in that target portfolio as a function of time horizon.
Some of this debate raged in the MFO discussion titled “Bonds, Be Gone”. For completeness, here is the Link to that discussion:
http://www.mutualfundobserver.com/discussions-3/#/discussion/8079/bonds-be-goneNot surprisingly, the research wizards conclude that the proper percentage is time dependent. The newer body of research emphasizes a tipping point between the accumulation and the distribution phases of a portfolio’s lifecycle.
The conventional wisdom had been that a bond allocation should increase with age to dampen volatility disruptions, especially critical soon after the distribution phase begins.
More controversial is the finding that current Monte Carlo-based research suggests that just before the retirement date, and soon afterward, the portfolio should go heavy into bonds to blunt the possible impact of any Black Swan events in this crucial timeframe. Further, these newer findings advocate an increase in equity positions as the retirement progresses to battle inflation and to augment the likelihood of portfolio survival.
Flexibility in annual drawdown rate, especially after a market downturn, remains a recommended tactic to enhance survival probability prospects. An obvious successful tactic to escape portfolio bankruptcy is to reduce withdrawal rates immediately after a market down year.
The standard portfolio wisdom almost never advocates a totally 100 % equity portfolio, except for perhaps the situation of an investor who is 30 years removed from any withdrawal needs. This is not a novel concept. It has been a constant part of retirement planning for centuries. Prudent investors like Benjamin Graham have consistently recommended this policy.
Benjamin Graham is recognized as one of the rare Wall Street masters. It is less well known that he was the teacher of many other Wall Street giants. That tiny group includes the likes of Warren Buffett, Bill Ruane, Walter Schloss, and a host of others identified in Buffett’s famous “The Superinvestors of Graham-and-Doddsville" paper.
Graham summarized his lessons from a lifetime of mostly successful investing in a little known lecture that he delivered in a November 1963 San Francisco presentation. His lessons learned are still pertinent today since the fundamental uncertainties of yesteryear are still relevant today. There is much investment sagacity in this 14 page record of his speech. Here is the Link to this Graham lecture treasure:
http://www.jasonzweig.com/documents/BG_speech_SF1963.pdfGraham warns that “Hence a large advance in the stock market is basically a sign for caution and not a reason for confidence”. The San Francisco presentation is dense with these common sense observations.
For example, Graham notes that the higher the market advances, the more the investor should mistrust its future advance.
Graham accepts wild market price fluctuations (volatility) as a rule rather than an exception. He claimed he gave up trying to make market predictions after 1914 because it was not a dependable, prudent investor’s game; he is very humble when he proclaims that even making a one year forecast is an unreliable, unproductive chore.
Even in 1963, Graham reluctantly acknowledged the difficulties that professional money managers encountered in beating appropriate market indices. He is skeptical about the efficacy of economic, stock market, and financial forecasting. The evidence suggests otherwise; predictions are notoriously error prone.
Graham preemptively makes the global Bill Sharpe argument about the requirement to balance all returns among the investment population before Bill Sharpe himself makes an identical case. What one active investor earns above some standard metric, another less fortunate investor must sacrifice.
Graham talks about the relative dividend gap between bonds and stocks, and highlights the modeling of this gap over the years. He defends a mixed fixed income-equity portfolio asset allocation that varies between 25 % to 75 % equity holdings. Although Graham favors a higher concentration of equity positions when the price is right (cheap), bonds are always part of the Graham ideal portfolio. He favors dollar cost averaging approaches. He likes mutual funds as an easy, cost effective way to fully diversify. He doubts that many investors have the skills and discipline to invest in individual stocks.
I strongly recommend that you access the Graham 1962 presentation. Although the quoted data are stale, the basic concepts retain their vitality. Be patient; the download is slow, but well worth the wait. Benjamin Graham’s market acumen and operational rules will make you a better investor.
Graham asserts that (from page 8) “… there is no indication that the investor can do better than the market averages by making his own selections or by taking expert advice.”
That’s a significant concession from a market legend. With the exposure and absorption of 5 decades of experience, Graham observed that he knew less and less about what the market would do, but he gained perspective on what investors ought to do.
In the end, without explicitly stating it, Graham was really touting passively managed Index mutual fund/ETFs since professional managers did not advance returns above general market rewards. Remember, in the 1962 lecture timeframe, Bogle’s Index fund dream was just starting to jell.
Graham concluded his lecture, as I will this post, with the positive admonition that “by following sound policies almost any investor- even in this insecure world – should be able to eat well enough without having to loss any sleep”. Amen to that.
Your comments are always welcomed and encouraged.
Best Regards.
Comments
For what it's worth, Zweig, in his chapter notes to his revision of The Intelligent Investor, emphasizes the same conclusion you make: DCAing into total market indices is probably the best strategy for those Graham calls defensive investors.
Hi Davidrmoran,
Yes, nobody denies that Superinvestors really do exist. Benjamin Graham himself and Warren Buffett serve as shining and irrefutable examples that beating the market happens. The issue is to identify these rare treasures a priori and their persistency beyond the happy discovery date.
Like you, I too have profited from a few fortunate mutual fund manager discoveries. Within the Fidelity fund family, my portfolio has benefited for over 20 years because of the stock selection skills of both Joel Tillinghast (FLPSX) and Will Danoff (FCNTX). Tillinghast continues to add to his illustrious record, but Danoff has stumbled over the last five years. I still own both funds. Superstar investment gurus are real, but are rare.
Keep in mind that my primary argument is statistical. That means that there will be both winners and losers. Even in his “Superinvestors” speech, Buffett acknowledged the power of the statistics. He mostly argued in favor of active fund management from an unlikely concentration of superior managers perspective. He identified a select investment talent concentration that had all been exposed to Graham’s teachings. Graham had the magic touch and also knew how to transfer that special knowledge to hungry students. Here is a Link to Buffett’s talk that was delivered at Columbia University in 1984: age has not tarnished its luster:
http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522
The basic Graham approach to seek value at an acceptable price, and to invest with a huge margin of safety to cover unfathomable uncertainties is still a winning way to invest. Many of the short list of successful professional investors still trade on his guidelines.
It is a challenging chore to identify superior fund managers who survive the marketplace’s frequent speed bumps. What worked yesterday might not work tomorrow. The Standard and Poors’ SPIVA and Persistency scorecards demonstrate this daunting challenge year after year. The failure rates exceed those anticipated from statistical Luck alone. Are active managers especially unlucky? No, the integrated research and fees cost structure is just too high a hurdle to consistently climb.
Passive Index proponents like Richard Ferri and Allan Roth have done countless Monte Carlo computer simulations that clearly illustrate the futility of expecting an actively composed mutual fund portfolio to outdistance an equivalent passively constructed portfolio. The odds of choosing a manager who outperforms his index benchmark ranges from 25 % to about 50 % for a single year. That likelihood substantially decreases as the number of active funds increases and as the timeframe expands. Many academic studies confirm this finding. Here is a Link to an article authored by Allan Roth:
http://daretobedull.com/download/Odds of Investing.pdf
A constant refrain from statistician Allan Roth is that you must “Know the odds of the game before investing”. Those odds are not very attractive when constructing a portfolio of entirely actively managed mutual funds. I elect to do a mix. I have a large portfolio that is mainly populated by passively managed Index products. However, a significant fraction is actively managed. I seek a balance that is the best from both worlds.
Congratulations on your past mutual fund selections. I hope they continue their outsized annual returns. Academic studies have concluded that even these outstanding managers stumble and experience bad years similar to professional athletes. These star managers will sometimes experience several years of sub-par performance. But they do recover. So be patient and stay the course. I do.
Please examine the references I provided. They are definitely not neutral, but strongly advocate their positions. There is certainly nothing immoral with honestly defending your position on any matter.
Thank you for taking time to contribute to this posting. It expanded the discussion horizon in a very positive manner. Graham was certainly not perfect in his market actions; nobody is. He resisted for a long time, but finally conceded that a passive approach was probably best for most investors. Exceptions for exceptional investors always exist. Perhaps you are a member of that small “band of brothers”. Your viewpoint is surely respected.
Best Wishes.