“The Little Book That Saves Your Assets: What the Rich Do to Stay Wealthy in Up and Down Markets” is written by David M. Darst, who is a very famous figure in asset allocation. He is a Managing Director at Morgan Stanley and serves as Chief Investment Strategist of its Global Wealth Management Group.
This book is filled with tons of questions. It reads very much like one of those business coaching books where their task is to give you thought-provoking questions to think for yourself, with little answers given. Everything depends. There is no right answer. There are always tons of factors to consider: objectives and goals, investment outlook, assets you own, personal financial situation, how much losses can you afford to suffer, when do you need funds, what is your mental make-up, what are your skill sets, etc. Some of the self-reflection questions can’t even be answered correctly by seasoned professionals, much less the general reader (e.g. is the economy weakening or strengthening?).
There are also tons of long analogies used in the book for simple concepts. If you take away all the analogies and questions, the book can probably be shrunk to 50 pages. I think it says something when one of the chapters ended with “Know yourself, know your needs.”
There are some good parts in the book. What I liked is the questions to ask when evaluating investment managers or manager-selectors. The book also had a nice table showing how each of the different asset classes contribute towards meeting investment objectives, as well as potential advantages and disadvantages of each asset class.
Reading the book tells me that doing asset allocation or financial planning is definitely not a path for me!
- Five steps to do asset allocation right
- Know yourself, your biases, your strengths and failings, your mental makeup and psychology.
- Decide whether you are really able to DIY or whether you should hire others.
- Have a framework to evaluate the resources that you will use yourself or that you will employ.
- Get input from a trusted, impartial source of life-wisdom and financial insight.
- Make a plan and force yourself to revisit it from time to time.
- At its heart, the essence of asset allocation is the search for non-correlation.
- A portfolio with more than 10 asset classes may be too diversified.
Asset Allocation Clock
What assets to emphasize during different periods
- Disinflation and deflation
- Focus on cash instruments, high-quality domestic and non-domestic bonds
- Economic recovery / low and moderate inflation
- Focus on domestic and non-domestic equities, high yield bonds, emerging market debt, private equity, and venture capital
- High inflation
- Focus on real assets, real estate, commodities, precious metals, inflation-protected securities, art, antiques, and collectibles
Objective-Based Asset Allocation
Consider what assets should be in your portfolio depending on whether they can meet your objectives. Your objectives should fall into one of the following:
- (I) Inflation Hedge – Protection against inflation
- (G) Economic Growth Exposure – Gain exposure to profitable companies and overall economic growth
- (D) Deflation Hedge – Protect overall portfolio from bad times
- (CF) Cash Flow – Portfolio to pay us
- (V) Volatility Hedge – Portfolio that doesn’t bounce all over the place
- (FX) Currency Risk – Exposure to worldwide currency movements to offset the impact a depreciating currency can have on your investments
Protection and exposure objectives met by each asset class:
- U.S.: I, G, CF
- Europe, developed asia, emerging market: I, G, CF, FX
- Fixed Income
- U.S. fixed income, U.S. short-term debt: D, CF, V
- High yield debt: G
- Developed non-U.S. debt: D, CF, V, FX
- Emerging market debt: D, CF, FX
- Alternative Investments
- Real estate and REITS: I, G, CF
- Real assets: I, G, V, FX
- Private equity: I, G
- Managed futures funds: V, FX
- Hedge funds: I, G, V, FX
- Inflation-indexed securities: I, G, D, CF, FX
- Cash/Cash Equivalents: D, CF, V, FX
Asset Allocation Approaches
Two basic approaches
- Strategic Asset Allocation
- Set long -term percentage weightings for the assets in your portfolio based on your objectives.
- Mix is maintained for long-periods of time. The portfolio is rebalanced when the target percentages increase or decrease.
- Tactical Asset Allocation
- Asset mix is adjusted to try to gain benefit from underlying market and economic trends.
- Focuses on finding and emphasizing asset classes with significant profit opportunities, and identifying and de-emphasizing asset classes that are expected to generate minimal or negative profits.
- It is difficult to determine when returns will go back to their long-term averages.
- One tool is to track the proportion of an individual industry group as a percentage of the S&P500. If a group as a whole has grown far beyond its average weighting (e.g. more than double), you may decide to cut back your allocation to the group.
- Another way is to look at the recent returns with respect to its historical average returns and the standard deviation of returns. From statistics, 68% of the time, the returns will be within 1 standard deviation of the mean. 95% of the time, the returns will be within 2 standard deviations of the mean (99.7% for 3 standard deviations). If the recent returns is ‘rare’, you may want to bet on mean reversion.
Selecting Investment Managers
10 Questions for Evaluating and Selecting Investment Managers
- Ethics – Written statement of professional experience and code of ethics.
- Philosophy and approach – Key tenets of investment philosophy and approach.
- Investment edge – Source of special investment insight, expertise, and edge.
- Disciplines and tools – Disciplines and tools used to determine when to buy, sell, or hold.
- Human capital – How the manager attracts, hires, trains, evaluates, and motivates its staff
- Performance history – Absolute and relative results under varying market conditions, standard deviations, correlations with other asset classes.
- Lessons learned – How the manager applies lessons from past investment mistakes.
- Costs – Detailed costs, turnover, tax efficiency information.
- Capture ratios – Percentage of upside captured during rising prices (upside capture ratio), and percentage of decline suffered during failing prices (downside capture ratio).
- Capabilities – Other important things that the manager wants to make sure that I know and understand.
5 Questions for Evaluating and Selecting Manager-Selectors
- Criteria – Quantitative and qualitative criteria most and least important in evaluating and selecting investment managers.
- Process – Processes to find, approve, monitor, and terminate investment managers. Details on the identity, frequency, and reasoning behind decisions to fire investment managers.
- Experiences – Positive and negative manager selection experiences on manager attributes that (1) analyzable and easy to find out; (2) analyzable and difficult to find out; and (3) unanalyzable but extremely important.
- Success factors – Evidence on the likelihood that the manager-selector is able to select first-quartile investment managers.
- Value added – Distinctive competencies in manager selection, and how those skills are translated into value added.