Content Provided by Case Eichenberger, CIMA – Senior Client Portfolio Manager

Focus on the Forest, Forget the Trees

File Under: Portfolio Management, Behavioral Investing

Omaha’s most famous billionaire, Warren Buffett, recently released his annual shareholder letter. The widely read letter always includes great tips for successful investing and some subtle jabs at certain industries. On page four of this year’s edition, Buffett talks about how we (clients, analysts, portfolio managers, etc.) can get lost by focusing on the smallest positions in a portfolio. This can lead to incorrect judgements and potentially bad outcomes.
Buffett talks about the “five groves” of Berkshire: the five most important elements that make up the company. These include clusters of businesses, financial assets, and insurance. At CLS, we have similar “groves” that make up our global, multi-asset portfolios. But these can be broken down into individual “trees” and “twigs.” Consider the snapshot below, which breaks down one client’s large-cap core equity holding.

It’s pretty easy to focus on a small tree, say, AbbVie Inc. (ABBV). The stock is down close to 14% this year. But taking a step back and focusing on the forest, we note that this position is a small percentage of the entire account. Focusing on the overarching allocations, as illustrated below, provides a clearer picture.

The four “groves” of our typical managed account are global equities, bonds, alternatives, and cash. Each has its spot in the portfolio, which should be judged as a whole. Focus on the forest, not the trees.

Actually, Adding International Stocks Lowers Portfolio Volatility

File Under: Diversification, Risk Management

I typically find myself reading more financial blogs than books. For me, it is more enjoyable and less of a time commitment. Recently, posted a blog by John Yeigh that discusses investing and sticking to all stocks in a portfolio. Yeigh made a statement I found to be a headscratcher. He said that he was invested in a “conservative stock portfolio.” Isn’t that an oxymoron? Even funds that focus on low-volatility stocks have at least two-thirds the beta* of the market. Is that “conservative” for most investors?
Yeigh also mentioned that he invested in broad, U.S.-only, stock index funds with no foreign market exposure. And he said this approach delivered lower portfolio volatility in 1987, 2000, and 2008. Maybe this did work. Let’s do some fact-checking. Looking at the chart below, is the 60/40 blend less volatile than the U.S. market alone?

All in all, international stocks actually lowered portfolio volatility in two of the three years the author selected. It’s important not to assume returns are the same as volatility. In fact, Vanguard recently released a new blog that shows adding international stocks lowers volatility and keeps returns in line.

Some Cool New Charts

File Under: Behavioral Finance, Misc.

Recently, Michael Mauboussin of Blue Mountain Capital released a new research paper. Mauboussin is a great writer and always has good insights. Below are some charts that I found interesting, followed by the impacts of the data and a note on why you should care.

Impact: As U.S. household equity rises, future U.S. returns are lowered.
Why you should care: International markets can supplement returns and help manage single-country risk.

Impact: Investors of all types tend to chase performance, attempt to time markets, and make bad decisions.
Why you should care: Employing a strong investment philosophy (relative value) and a disciplined risk management process (Risk Budgeting) may help us avoid behavioral biases.

Impact: Human nature dictates losses hurt more than gains feel good.
Why you should care: Use probabilities to tilt the scales of investing in your favor and always stay invested.
Thank you for reading.
*Beta is a measure of the volatility, or systematic risk of a security or a portfolio in comparison to the market as a whole.