- Martin Sosnoff
The 60/40 Investment Construct A Myth Of Conservatism
I was a Great Depression baby. I remember my mother dangling down a sugar cube over the porcelain kitchen table. My parents would gaze at the cube while sipping their coffee. In the thirties, the price of sugar was maybe 11 cents a pound. Prices just ratcheted up along with every other commodity. Gasoline at 21 cents a gallon, too.
On a steep hill, my parents’ friends with cars would turn off the ignition and coast down to the bottom. The New York City school system then was outstanding, right through City College. We grew up in Harlem, but never felt disadvantaged thanks to Mayor LaGuardia.
Seventy years later, wealth creation has proliferated, not just for the top 0.1% of the population but for the middle class as well. They sit with mortgage free homes and financial assets worth hundreds of thousands. But, even among the very rich, few know anything about managing their financial assets.
Such funds, whether pension assets or accumulated wealth, mainly get earmarked to banks, insurance companies and brokers who long ago established wealth management subsidiaries. Today, they are enormous profit centers with substantive cash flow from new and an established clientele.
Wealth management runs into tens of trillions. It’s built mainly on the construct of a 60/40 ratio. That is 60% in equities and 40% in bonds and all other categories like currencies, venture capital and fixed-income paper, both in the U.S. and abroad.
A veneer of conservatism permeates these investments. Clients lose no sleep. They understand they’re not going to the moon, but neither will they be left penniless and thrown out on the street with just furniture and fixtures.
Maybe, it doesn’t matter too much that client portfolios underperform their index by a couple of percentage points over a 5-year period. After all, even Warren Buffett’s Berkshire Hathaway has run into underperforming periods that lasted over 5 years.
Buffett notes that management fees, particularly for hedge funds, do eat seriously into long-term portfolio performance. It raises the question of whether investors can’t cut through the mufti pufti of their portfolio’s construct and do it themselves. Why not buy into a major index fund, occasionally shift some funds into NASDAQ and buy a couple of ETF bond funds? Fees run lower, but not so low as to be insignificant. A high-yield bond fund can run an expense ratio approaching 1%. Further, if you’re buying into an index like the Dow Jones, you should understand that its components have changed.
UnitedHealth Group and Boeing are top components of this index. As for the NASDAQ 100, the top half dozen names comprise nearly half the index. They are all tech houses selling at big premiums to the S&P 500 Index. Make sure this is what you want. Volatility of the index can run at twice the norm even in a short down cycle, say one year.
Lemme go back to the investment pie constructs used by all major wealth management houses, particularly banks. On the surface, the picture adumbrates a sober conservatism, an all-embracing methodology that considers every kind of investment construct that exists, worldwide.
TYPICAL ASSET ALLOCATION
In reality, managers earmark assets mainly to large-capitalization equities in the U.S. domain. The fixed-income sector goes into investment grade bonds, inclusive of Treasuries and corporates. Rarely, do these houses buy into NASDAQ or into the high-yield bond sector. Emerging markets and global equity investments are minimal.
In short, some 70% of investments are confined to U.S. equities and bonds - for better or worse. Lest we forget, in the financial house cave-in, 2008 - ‘09, Bank of America needed a Buffett bail-out. Merrill Lynch was merged out and Lehman Brothers was put into liquidation. Can equity placements in Japan better mid-capitalization U.S. equities? ¿Quién Sabe?
When I last reviewed JPMorgan Chase’s money management results over a 3-year period I found underperformance by a couple of percentage points. This is unacceptable. I’m skeptical that bank wealth managers would early-on get out of the way of a bear market, say raising 20% or more in cash or overweight oil while deemphasizing technology houses.
Bank of America at yearend showed record client balances of $3.8 trillion, up 15% for the year. Net income of $1.2 billion carried a pretax profit margin of 30% and made this a major profit center. Money management is much more stable than net interest margins in the banking business which right now rest flattish, needing higher interest rates.
Never be enthralled by pie-chart money management. These white-shoe operators construct client portfolios so as never to underperform benchmarks by more than a couple of percentage points, year-over-year.
You never see them take a major interest in the NASDAQ 100 or in high-yield bonds. Mainly, they stick with the S&P 500 Index and with investment-grade bonds and even low-yielding Treasuries (under 2%). Let’s put aside offshore investments which seem so dismal. In many instances banks farm out capital to specialty firms, like hedge funds so clients pay double fees.
My portfolio takes a radical approach to investment concentration in just a couple of sectors. It’s themed for raw materials inflation starting with energy and natural resources like aluminum. With the exception of a low-cost basis Microsoft, I don’t inventory tech houses, not even Apple. But, Exxon Mobil is a 10% position. And several master limited partnerships like Enterprise Products Partners. I’m 30% in energy paper which is running contrapuntally to the horror show.
Natural resource stocks soared to the moon, past 18 months. Analysts now debate whether Alcoa is worth north of $80. Eighteen months ago it sold in the teens. Sadly, I banged out U.S. Steel, Freeport-McMoRan and Halliburton. Sole growth stocks I inventory are in healthcare, namely UnitedHealth Group and Zoetis.
Theme your portfolio. Who’s to buy Russian oil? Go, Exxon! Let the banks ponder their pie charts.