Monday, November 28, 2011

The Brutal Realities of Calendar Year Reporting

The year is rapidly coming to a close, and 2011 will be remembered by Pinnacle’s investment team as one of the more difficult in recent memory. The financial markets have faced a variety of challenges, including those caused by natural disasters (the tsunami, earthquake, and nuclear meltdown in Japan), political upheavals (the Arab Spring, U.S. debt downgrades, and ongoing political gridlock), and financial turmoil (the European crisis). The investment team has responded to changing market conditions with a series of transactions that, for the most part, have reduced the risk in our managed accounts in anticipation of volatile markets. By my count we have executed more than thirty trades since June of this year, and more than one hundred transactions since January, each of which has been the subject of intense debate within the team. I hope to never again sit in on a meeting where the topic of discussion is the implications of a cloud of radioactivity drifting over a major industrial city.

Yet for all the hard work, we come to the last month of the year with Pinnacle portfolios basically breaking even versus our various benchmarks for both year-to-date absolute performance and year-to-date relative performance. For those investors who tend to think in terms of “How much did I make?” the year is going to be disappointing. Even a big December rally won’t rescue what is likely to be small single digit returns for the year. Of course, investors who think in relative terms are still in the game. If the markets continue to sell-off as they have over the last couple of weeks, we have an opportunity to beat our benchmarks by several hundred basis points. In a year or two no one will remember all of the work that went into earning our returns in 2011 -- all they will see is the calendar year number buried along with all of our other calendar year numbers.

It is precisely this state of affairs that causes so much mischief in the world of professional investors. The fact that four weeks of performance will dictate how others judge your entire year doesn’t seem fair…but there it is. Unlike the hedge funds that will most certainly ‘game’ whatever is to come in the next month in the hope of making their year, there is nothing in Pinnacle’s playbook that would allow us to do the same. While we’re certainly not passive investors with no tools to take advantage of market opportunities, we simply don’t operate with a four week time horizon, and we won’t change the portfolio positioning from defensive to aggressive in order to try to catch a flash market rally that could reverse at any time. It is possible that the markets will continue to sell-off during the month of December, in which case we will be big relative winners due to the defensive character of our current portfolio asset allocation. On the other hand, the market could easily rally if the market becomes too oversold in the short-term... or if we have a typical “Santa Claus” rally... or if the Fed announces QE3... or if the ECB announces its own quantitative easing program...

It’s going to be an interesting four weeks. Stay tuned.