Tuesday, November 2, 2010

Eight Years Young

October marked the eight year anniversary of Pinnacle’s official GIPS compliant investment track record. It has been quite a journey. Eight years ago we were recovering from a traumatic bear market. Having “dodged a bullet” during the market decline because asset class correlations remained low and diversification did its work in limiting losses, we began to explore the possibility that buy and hold investing, known to us as strategic asset allocation, was not the best way to manage risk for Pinnacle clients. After a year and a half of discussions, we went ahead and restructured our entire investment business. Eight years later, I believe that we can claim more than our share of success in our effort to create an industry leading tactical and active portfolio management process.

In retrospect, I believe that our best insight in creating and implementing our new active strategy was the idea of creating volatility constraints for different Pinnacle investment strategies by using the back-tested results of strategically diversified (buy and hold) portfolios, which was not new. What was different was to allow the investment team to invest within the back-tested policy constraints for risk without any constraints in terms of what assets we could own for each risk strategy. By not targeting asset specific allocations for each portfolio policy we created an environment where Pinnacle analysts were free to recommend virtually any asset class for our portfolios as long as they met our definition of good value. Over time we’ve come to evaluate value in terms of traditional valuation, the market cycle, and market psychology or technical analysis. We utilize both quantitative and qualitative techniques to make investment decisions. We rely on what is now a very experienced team of analysts to apply the rules and make good decisions. And we continue to believe that we can win for our clients by not losing, both in terms of losing dollars due to bear market cycles, and losing in terms of making large and wrong asset allocation bets in the portfolio.

I think it’s fair to say that we couldn’t articulate much of the above eight years ago. We remind ourselves virtually every day that active management is a lifetime learning assignment. As long as we incorporate judgment and informed intuition into our decision making process, then we must defend against making investment mistakes. If we forget this lesson regarding lifetime learning, then we can count on the markets to remind us. We have learned that this is a humbling business that requires a brutal amount of hard work to be successful. It is too bad that our investment process simply does not allow us to fall into a lucky call that will be a “career” trade. The reason is, of course, that the implications of being wrong are too serious to make the big bet. That leaves us with trying to hit the singles and doubles necessary to gradually and systematically deliver outperformance on behalf of our clients. I’m looking forward to the next eight years.