I received an email from a reader who suggested that someone should offer a balanced fund that is more focused on preserving capital.  Rather than being stuck on a set asset mix, as most balanced funds are, the fund would have the scope to move between fixed income and equities.  As he described it, “[The fund’s] fixed income portion would vary from 50 to 75% as markets change.  When equity markets are undervalued, the manager would step up the equity percentage to 50%.  Conversely when equity markets seem overvalued, the cautious thing to do is to rebalance to lower levels of equity investment.”

The reader was fortunate enough to anticipate the downturn and had re-balanced his own portfolio.  Other people he knew had done the same. He feels that professionals should have seen it too and acted more decisively to preserve their clients’ capital.

In responding, let me first say that I am sympathetic to the view that most funds are too constrained by rules and limitations, and firms are unwilling to have the performance deviate from what similar funds are doing.  As a result, even conservative balanced funds get caught up in the performance game and are slow to batten down the hatches.

And I’m in agreement that we should be willing to shift our asset mix in the context of market conditions. Indeed, we have set up Steadyhand with the express notion of addressing this issue. Our fund managers have few constraints on them and can move decisively to where they see value. And while they are aiming to beat the indexes and competition in the long term, they pay them little heed in the short term.

But, and there is a but, we have to be careful in thinking that we can be so confident in our market view as to consistently get our asset mix shifts right. Given what has happened, it’s easy to think that our current predicament was foreseeable by everyone. At times like this, we are prone to suffer from hindsight bias, which is “the inclination to see events that have occurred as more predictable than they in fact were before they took place.”

Our reader is to be congratulated for his sound judgment and good fortune, but he has to realize he beat the odds. What he did is hard to do because it involves making a correct call on the future outlook as well as assessing how much of that outlook is priced into the market. And then those two things have to be done again when the shift is reversed.

I’m not trying to be defeatist here, nor am I suggesting that every decision has to be perfect to enhance returns, but we need to go into it knowing how complex and challenging it is to be an asset mix shifter.

At Steadyhand, our approach to asset allocation is simple, and I’m sure somewhat unsatisfying to many investors.  It goes like this:

• The key is having a long-term (strategic) mix — i.e. if you’re young, you own lots of equities; if you’re older and drawing on your portfolio, you own mostly fixed income; and a few variations in between.
• For most investors, asset shifts should be as automatic as possible — i.e. periodic rebalancing back to the long-term mix. The goal is to take emotion and market-timing out of the equation.
• More experienced investors, or ones that rely on an experienced advisor such as Steadyhand, can ‘shade’ their mix towards their view of the world and market valuation.  By ‘shading’ as opposed to ‘shifting’, they will benefit from good decisions, but not be blown away by bad ones.