Macroeconomics at the Intersection of Investment Strategy

Overview

In the wake of the financial crisis and an uncertain economic outlook, it is timely to think afresh and evaluate new approaches to investing. Dr. Sam Thomas, professor of banking and finance at the Weatherhead School of Management, Case Western Reserve University, discusses what the changing ‘architecture of global commerce’ means for asset allocation and how families need to be thinking about portfolio risk at the 2012 Global Investment Forum.

Key areas of focus:
  • The importance of diversification in the wake of the financial crisis 
  • Exploring the difference and value of a static versus dynamic asset allocation model 
Dr. Thomas made some introductory remarks centered on a thesis, supported by empirical back-testing, that dynamic asset allocation yields superior long-term investment returns. Investors should adjust their risk tolerance based on the macroeconomic environment. He commented: “As individuals, we rarely know the boundaries of our behavior. A successful long-term investment strategy is partly protocol-driven, partly informed by your personal strengths”. 
 
The two fundamental approaches to asset allocation are static vs. dynamic asset allocation (static asset allocation is based on traditional Markowitz portfolio theory)
  • Stationarity versus non-stationarity in probability distributions of asset class returns 
  • Stationarity versus non-stationarity of correlations in asset class returns 
  • Constant versus evolving risk tolerance/preferences 
  • Non-stationarity is driven by, or influenced by, states and phases of the real business cycle in the real macro economy 
The above implies that investors have 3 options:
  • Static, buy-and-hold
  • Static, with annual rebalancing
  • Dynamic, with annual rebalancing 
To do the latter, i.e. dynamic, with annual rebalancing, it is imperative to constantly monitor indicators (not just isolated indicators but the overall story they paint) and adjust your portfolio accordingly because you cannot accurately forecast. 
 
Key observations by panelists:
 
Marc Hendriks
  • “The basis of our investment strategy focuses on 2 key variables: rates of change in interest rates (standard deviation against a 3-year average) plus GDP growth”
  • “Investment criteria is specific to the individual family office (regulatory requirements also drive reporting)” 
Henley Smith
  • “We use cash and long-only in both public and private equity as a counter-cyclical play”
  •  “We are not a fan of emerging markets fixed income. For us, they are more a currency hedge” 
John Phelan
  • “Decision-making by committee are consensus bets – 20-30% of the time, you will be wrong if you go against the consensus and it can cost you dearly but that is the risk you run for being a contrarian” 
  • “There is a confusion between macroeconomic, capital market and specific business variables that impact the businesses you are invested in”
Lawrence Golub
  • “The term fixed income is a misnomer: Fixed income is not fixed, neither does it generate much income”
  • “Holding substantial cash positions is a form of ‘dry powder’ for rare opportunistic investments”

Presentations

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