CAPTRUST Chief Investment Officer
“ He don’t put a bolt to a nut, he don’t tell you the law or give you medicine. He’s a man way out there in the blue, riding on a smile and a shoeshine.”
—Arthur Miller, Death of a Salesman
My wife and I found ourselves in New York a few months ago sans our three young children who were being spoiled rotten by their grandmother. I had a series of business meetings over two days and despite a sliver of time to spend together we decided to make the journey anyway. By chance I saw an advertisement for Arthur Miller’s classic Death of a Salesman on Broadway starring Philip Seymour Hoffman as Willy Loman, although I didn’t think it would be possible to see the production given such a tight schedule.
However, at the last minute a Client converted a scheduled dinner meeting into a shorter discussion and suddenly the Broadway production became a possibility. My wife Jamie swiftly picked up some tickets and an hour later we took our seats at the historic Ethel Barrymore Theater on 47th Street. The lights dimmed, and for what we were about to witness seatbelts should have been made available to the audience.
I developed a great appreciation for drama during my undergrad years after signing up for a theatre class to ostensibly lighten my course load one semester. I quickly learned that my attempt to ease was in vain; the stage was no pushover. I have always been a huge Hoffman fan, having loved his work in Scent of a Woman, Moneyball and Capote, for which he received an Academy Award. However, his 1994 appearance in the lesser known Nobody’s Fool, which tells the story of a fictitious central New York (my and Hoffman’s shared home region) town, remains my sentimental favorite as he was cast early in his career alongside legends like Paul Newman and Jessica Tandy, a foreshadowing of Hoffman’s pending greatness.
The entire cast of Death of a Salesman was phenomenal, but Hoffman was nothing short of captivating. He was a life force on stage, effortlessly shedding all other characters I had associated him with and forcing the theatre’s patrons to accompany him on title character Willy Loman’s downward spiral, swiftly summarized by this missive’s opening quote.
The production’s only downside was the precedent the play set; I am not sure I will ever witness such artistry again. I recommended the production to Mark Davis, a colleague out of our Los Angeles office who happened to be traveling to New York the following week. Mark was a professional actor earlier in his career, and he too was blown away. Both a neophyte armchair quarterback (me) and a credentialed thespian (Davis) left 47th Street in amazement.
So what makes Hoffman so good? I am sure lots of things, but one key component to success across disciplines is repetitions or “reps.” Malcolm Gladwell devotes an entire chapter of his bestselling book Outliers to what he calls the “10,000 hour rule,” or the fact that musicians like the Beatles, composers like Mozart and programmers like Bill Gates reach elite status after putting in the rough equivalent of 10 years of dedicated practice in their chosen field. Gladwell proclaims that, “Ten thousand hours is the magic number of greatness.”1 Newly crowned Masters champion Bubba Watson candidly described his jaw-dropping approach shot that closed out his playoff match en route to his first green jacket: “Hooked it about 40 yards, hit about 15 feet off the ground until it got under the tree and started rising. Pretty easy.”2 Pretty easy? Only if you have put in the time to envision that shot and then hit it the same way you did over and over while practicing. Hoffman, through his education, professional training, as well as Broadway and Hollywood experience as both actor and director has put in the time to be great. Hoffman’s cumulative “reps” that preceded that Monday night performance at the Barrymore led to as fine a performance as I have ever seen or could ever hope to see.
Investing is also rumored to be a cumulative knowledge-based endeavor. Invariably the goal, whether the methodology incorporates actuarial (quantitative) variables or clinical (qualitative) information, is to learn from experiences, price patterns, and economic scenarios and make future judgments accordingly. Simplifying their methods somewhat, “quants” build models by developing pattern-seeking algorithms designed to provide clues about where a given asset may move based on historical relationships. At the opposite end of the spectrum, strictly qualitative processes often liken the current market environment to a prior one and make decisions based on past outcomes. In the “quants’” case, model quality and continuous predictive ability carries the day, while qualitative success relies on being sure that the past is a prologue and that you have matched the “right” past to present circumstances.
Certainly things like grey hair, sheer intelligence, education and training hold legitimate claims on investment success, but I offer that situational awareness, driven by a combination of actuarial and clinical processes, is the key to investment success. Dawes, Faust and Meehl nailed it in their seminal 1989 Science article (required reading for all CAPTRUST research team members) where the authors argue that strictly clinical processes had significant limitations and “upward bounds” to predictive ability exist in still superior actuarial methods.3 The researchers conclude that combining the two processes by relying on actuarial methods while being open “to new approaches and variables that ultimately increase our explanatory and predictive powers” may help in bettering decision making.4
Simply said, “reps” alone won’t cut it in the present investment climate. Situational awareness through both clinical and actuarial processes will be critical for investment success, because history does not provide relevant clues for today’s investment environment. We have not seen a macroeconomic environment like the present one, irrespective of the flood of hypotheses that enter my inbox every day about how this period mirrors some prior period and the elixir is to sell this and buy that. This time is different for two reasons: (1) extremely and pervasively low interest rates and (2) a highly erratic pattern of central bank accommodation. In over 131 years of recorded data (Figure 1), we have never seen interest rates this low, impacting price movements and correlations across global asset classes. Traditional relationships between stocks, bonds, metals, real estate and other securities have been and will likely continue to be challenged by low rates.
Second, erratic central bank stimulus has led to a somewhat predictable pattern across broad market activity.
This pattern started in late 2008/early 2009 with the Fed’s initial quantitative easing program (QE1), which ended in early 2010 and whose dénouement was met with selling until the introduction of QE2 in late 2010. Once QE2 ended, markets again sold off until Operation Twist5 began in late 2011. In the first quarter of 2012, we saw heightened stimulus measures from Europe, the UK and Japan in addition to ongoing bond purchases by the U.S. Federal Reserve via Operation Twist. Thus far in the second quarter, Europe and the U.S. have not signaled additional stimulus and riskier asset classes have sold off on what appears to be weakening macroeconomic data across both advanced and emerging economies, but perhaps not weak enough to warrant additional central bank aid.
So how does one invest in this environment? How does CAPTRUST intend to add value and avoid being reduced to “riding on a smile and a shoeshine” when meeting with Clients? For one thing, we have been adamant about not being heroic; the global economy remains on unstable footing and a wide range of potential outcomes means investors should spread out portfolio risk accordingly. Fixed Income remains a flashpoint in the media and a frequent Client question. While many of our peers have advocated dumping bonds after a cursory look at the movement of bond yields, our stance has been to pay close attention to sub-sector allocations within Fixed Income and look across the entire bond market for opportunities. Should European sovereign problems grip markets again or Emerging Market growth slowing hurt corporate earnings, Treasury prices will likely rise. However, should future central bank accommodation arrive in size, stoking inflationary fears, Treasuries are unlikely to be your friend. Irrespective, using history to back this claim (but again cautioning against too many conclusions being drawn from the past), just because Treasury rates head higher, not all bonds will necessarily lose value at the same time or to the same degree (the Barclays Capital Aggregate represents a broad index of U.S. Fixed Income).
Our advice? Two-pronged.
First, spread out portfolio risks across and within asset classes. Policymaker-driven markets have no historical script from which investing actors can credibly read, so spreading out risks across asset classes (bonds, stocks, alternative strategies where appropriate and other asset classes), which admittedly is standard financial advisor advice, will be important. However, our perspective is that the highest chance for a good outcome is a highly complicated layer beneath the generic “be diversified” mantra. In order to be truly diversified in the current environment, one has to be very cognizant of the interrelationships within asset classes. We spend much of our time assessing how various sub-asset classes will co-move based on the variety of potential outcomes in a policymaker-dominated investment environment. We don’t see that environment changing in the near term, and both cross-asset and intra-asset diversification should be enduring portfolio construction themes.
Second, go see Philip Seymour Hoffman act in person. That is worth a smile, a shoeshine and certainly the price of admission.
1 Gladwell, Malcolm. Outliers: The Story of Success. New York: Little, Brown and Company, 2008, page 41
3 Dawes, Robyn and David Faust and Paul Meehl. “Clinical Versus Actuarial Judgment.” Science, Volume 243, March 31 1989, page 1673
5 The Federal Reserve’s Operation Twist aims to sell medium term bonds and using the proceeds will buy longer term bonds with the goal of lowering interest rates on the 10-year bonds. This should drive down interest rates across the board