If you look at my resume or even my profile on my expert witness website, you will see that I consider one of my core competencies to be the area of investment management that is often referred to as wealth management. While that term can be applied to almost any sort of financial instrument investment process (wealth being generic term not necessarily confined to any market segments), it is generally applied to the accumulation of asset value by individuals or organizations and foundations/endowments. Their common connection is that they are not holding the assets for active profit generation, but rather passive accrual. Even that definition or categorization is not absolute because some portfolio assets (take for example rental real estate) straddle the notions of active and passive holdings. But corporations and going concerns use their assets quite differently and thus the way they position their portfolios needs to be looked at differently than those who are positioning for long term accumulation in and of itself. A company that keeps cash on hand for working capital liquidity or possibly strategic actions is very different from a person who keeps a certain allocation in cash in their portfolio, either for risk balancing or opportunistically to market time other investments.
The main strategic portfolio decision most often has to do with what form of financial instruments in the capital stack of going concerns one finds most attractive from a risk/reward perspective. The two most common forms (other than cash or highly liquid instruments held for that purpose) are bonds and stocks. The basic recognizable balancing act is how the allocations to those two categories fit the risk appetites of the holders…40/60. 80/20 or some other mix. Understanding the fundamental attributes of bonds versus stocks is the foundation of portfolio investing. The world seems never to be completely satisfied with simplicity, so for a long time people have engineered variations of those two basic instruments ostensibly to alter the risk/return, though more likely to sell the latest financial product and often to incorporate added elements like leverage into the mix. It’s not unlike an artist with a color pallet. There are primary colors (red, blue, yellow) and then multiple variations from there. It’s not quite so simple in investing because these financial instruments are multi-faceted and therefore subject to more external elements.
I am regularly called upon in my expert witness capacity to consider situations where the prudence of investment decisions is called into question. I am looking at one such situation right now where the entire civil litigation boils down to whether a financial advisor, acting as a fiduciary should have had a certain portfolio allocated to 100% stocks or something more “balanced” like 55/45 with the addition of bonds. It doesn’t take a genius to realize that this sort of claim in litigation is usually the result of a period of sharp decline in stock values wherein the beneficiary of the portfolio feels aggrieved due to the loss in value of the portfolio. Pretty standard stuff, right? Maybe yes and maybe no.
During the span of my career (basically 1976 to the present…48 years), extensive academic work on financial instruments created what is known as a financial engineering trend where newer and more complex instruments were created to embody the elements of risk and return in various relationships to one another. While some of these notions are as old as the Phoenicians, I think its fair to say that the definitions brought to bear by the financial engineering research created a proliferation of these new forms of investing. In many ways, this trend defined my time in the arena of finance. FInance is, by its nature, a conservative arena and the field does not change up its fundamental measures easily or quickly. These new instruments have gradually grown in use to the point where they are grouped into what are called alternative investments. The truth is that even within the grouping of alternatives, there are many, many forms that are offered that have many of the primary colors of financial building blocks imbedded into them. In other words, adding a new category to the array called “alternatives” has not really added clarity to the decision-making of portfolio construction even though it has enabled observers to have a bucket that feels better to those needing to define investments in terms of their relative prudence.
In addition, there are other financial fads which come on the scene and try to break into the investor array by suggesting that they are different. Years ago, foreign currency (FX) became more generally accessible as a pseudo asset class only gradually to be spread out like leverage (borrowing against holdings to increase market exposure) or optionality (contingent claim instruments) as a feature of the primary instruments. With the recent flurry of interest in crypto-currency (blockchain-based digital encryption algorithms that allow for untethered payment mechanisms), it too is now being treated as an asset class. It’s construction implies that it is unlike leverage, currency or optionality, but its lack of connection to underlying profit-making going concerns makes it a very confusing species that may be a new asset class or may not.
What got me started down this monologue on portfolio allocation is not that I miss it all so very much as a LinkedIn message I saw from one of my favorite ex-Wall Street colleagues, a guy who worked for me starting 35 years ago, who I invested with, who I rehired about 20 years ago and who now has a very successful boutique all his own (though I got one of my VC funds to put a few shekels in it too). He is my go-to guy on many financial topics, most notably alternatives and crypto, as his company acts as a prime broker, record keeper and custodian for those specialized classes. He is a no bullshit guy who is solid as a rock and he posts regularly on topics of interest in the financial world. He sent out a post showing a recent B of A Wealth Management survey that shows that the average portfolio allocation of under 45-year-olds is radically different from the over 45-year-old set. The older set allocation looks sort of like the traditional 60/40 equity/bond mix with a dollop of cash and a dabbling in Alternatives and Crypto. But the younger portfolio was radically different with something like only 28% in equity and huge chunks of Alternatives and Crypto. It was a surprising realization of what most of us would have guessed was a small lean in that direction for younger investors, but turns out to be a dramatic change in their preferences and outlooks. This requires significant further study by behavioral finance sorts, but if it is driven solely and objectively by return expectations and correlations, then the entire business community had better start thinking about how to fund itself differently and investors had better change their allocation thinking rather dramatically.
There are some definitional refinements that would have to be made first before seeing what this says about appetite for equities because Alternatives could easily be another way to express that outlook. In other words, maybe Alternatives need to be reclassified based on their underlying risk elements rather than the title on the cover of the offering memorandum. My guess is that there are elements of both at work here, but what it does suggest, especially for investment advisors, is that they need to seriously update their investor voir dire process and probably their entire allocation systems. The new generation needs to be understood properly in terms of their investment appetites in order to properly and prudently serve their needs. All that money being managed for the Baby Boomers is on the cusp of shifting into the hands of their children and advisors have precious little time to adjust and reallocate to suit their wishes.