What's Your Process for Making Portfolio Changes?

"To get something done a committee should consist of no more than three people, two of whom are absent." - Robert Copeland, U.S. Navy Admiral


We were sitting in a large, mostly empty conference room. It seemed like an unnecessary amount of space for three people. Graphs, charts, research papers, and quarterly market commentary from various Wall Street firms were strewn across the vast oak table.


Our Chief Investment Officer (CIO) leans back in his chair. He must've been on his fourth cup of steaming hot black coffee. He peers across the room at myself and another portfolio manager. I purposefully avoid eye contact because I know what's coming next.


"Where do you guys think this market is going?"


He pivots his chair towards me, a green junior analyst who looks barely old enough to order a beer.


I play the game, spouting off stat after stat of useless economic and market data. I had become fond of David Rosenberg's newsletter "Breakfast with Dave," a bearish Canadian investment professional (this would later inspire the name "Sunday Coffee Reads"). I'm especially fired up about Dave's work due to a recent e-mail exchange between the two of us. My rambling response to the CIO ends with an opinion the market has more room to drop.


The portfolio manager is up next. I have no clue what he is saying, but it's a similar tone, although he's pessimistic for reasons different than mine.


Our veteran CIO takes another swig of Joe. He slowly sets his coffee mug down, missing the coaster completely.

"I think we've capitulated. We've hit the market bottom. We have nothing but upside from here. Would you all agree?"


He always uses the word "capitulated." I didn't even know what that meant. Despite listening to 30 minutes of why we were pessimistic on the market's prospects, our boss was now asking us to agree with his sunny conclusion without even bothering to give analysis or an explanation. It was clear he didn't listen to a damn word we said.


Portfolio Manager: "Yes"


Me: "Yes"


You see, despite looking like a foolish minion, there's an element of career risk going against the boss, especially as a newbie trying to kick-start one's career. This was the summer of 2008. Welcome to the world of how investment committees often operate and how firm-wide asset allocation decisions can get implemented.


Fancy suits sitting around a conference room table, each sharing their version of what happens next based on their own narrow experiences of the world. I was reading doomsday newsletters and watching the market plunge day after day in 2008. Hence, my forecast was bearish. The CIO was a baby boomer that came up during the prosperous 80’s and 90’s. He was looking for any reason to be bullish.


The process is outdated and slow. It's wrought with human bias. It reeks of groupthink. Everyone in the room has a different agenda or angle to play. At the end of the day, most will fall in-line with the boss (CIO). That's not a process, that's a crapshoot.


Whether you're a do-it-yourself investor or a client of an investment firm, it's more important than ever to have a framework & process for managing risk.


Here's how Pure Portfolios makes firm-wide allocation changes during periods of market turmoil.


Asset Class Framework


Let's say we are willing to accept the investment outcomes for a 50% stock & 50% bond portfolio. Within our framework, we set range limits for our asset allocation. This allows us to adjust risk up or down within a framework, rather than taking huge deviations from our 50/50 asset class targets.


Rebalance Window


We make tactical adjustments every 30 days, usually at the beginning of the month. A defined rebalance window prevents us from making hasty allocation changes based on short-term market noise. Rather, we use the rebalance window to run our proprietary screens to add or reduce risk in client portfolios.


Momentum & Trend Rules


Rather than human judgement, we rely on momentum & trend rules to make tactical allocation changes. Empirical evidence suggests that implementing momentum & trend can reduce major portfolio drawdowns, which is important for pre-retirees & retirees. You can read more about our rules-based investment process here.


We have a few other factors, including a Federal Reserve rule and passing our human logic test, but we don't want to give away all of our secrets.


Individually, these might not seem like much, but taken together makes for a powerful risk management process. We are aware that humans have emotional and cognitive biases that flare up during volatile times. Therefore, we have instituted a set of rules to reduce drawdowns during tough market environments. Buy & hold, stay the course, buy the dip, etc. are fine for young people or those with time on their side. It can be disastrous for pre-retirees and retirees that depend on their portfolios to fund their lifestyle.


If you're feeling nervous about the market action this week, ask yourself or your advisor about their risk management process. It could be the most important question you ask in 2020.

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