Meditations on Money Management

Silton: Beginning of year is a good time to evaluate your portfolio

CorrespondentJanuary 11, 2014 

The onset of the New Year is money management’s opportunity to get you to make changes in your portfolio. Whether you are a retail investor or a large institution, money managers view the upcoming months as a big marketing opportunity.

The fortunate few who beat the market last year will be looking to entice investors into their funds. Expect to see plenty of newspaper ads and magazine articles extolling the intellectual prowess of the top quartile managers of 2013. The big mutual fund houses will suggest that it’s time to give your portfolio a checkup. Institutional money managers will advise their endowment and pension clients to rebalance their portfolio or swap a growth mandate for a value one or visa versa.

Most of the advice will be based on what’s working for the money manager. For example, if a small cap product looks competitive, you’ll probably hear a pitch about the benefits of investing in small companies.

Although you should be cautious about these entreaties, it is a good idea to take a look at your investments periodically. Before we get too far into 2014, you, your financial adviser or broker should evaluate your investments. Unless something has changed dramatically in your financial situation or your portfolio is acting strangely (e.g. going down in value in a rising market), quite often the best decision is to do nothing.

Review asset allocation

The most important part of the self-examination is a quick review of the asset allocation. How much do you own in stocks, bonds and perhaps real estate? Have the percentages changed much in the last year? For example, if your assets are usually about 50 percent stocks and 50 percent bonds, you probably don’t need to do anything to get back to those proportions unless the stock or bond proportions have risen to something like 60 percent.

In examining your asset allocation, be sure that you take a comprehensive look. All too often investors only look at the asset allocation in each of their accounts. For example, they’ll separately check the allocation in their 401(k) and taxable accounts. Frequently they’ll forget to include company stock or options. If a home is supposed to eventually provide retirement funds, its contribution to the asset allocation shouldn’t be overlooked.

Having reviewed the asset allocation, it’s a good idea to take a look at your managers or funds. In my view, you should focus on those managers or funds that have performed very badly and those that have done extremely well. Those managers and funds that are within several percentage points of the market averages can probably be left alone. The extreme laggards, particularly if they’ve trailed their benchmarks for more than a year, should receive detailed scrutiny. However, the extreme winners are also suspect because their unusually good performance is probably the byproduct of luck and will often be followed by mediocre performance (known as a regression to the mean).

In evaluating the big winners and losers, you’ll want to know why they soared or sank. Has your winning manager fallen in love with a couple of stocks? Has he become too enamored of a particular sector of the market? Has he suddenly started trading like a speculator? Is he feeding on a steady diet of IPOs? Unless you signed on for a concentrated investment portfolio, high frequency trading, or IPOs, these types of changes should be warning signs.

You should also be suspicious of any fund where the portfolio manager has changed or the investment company is being sold. These types of changes are distractions that usually hurt your investment performance.

Consider tax consequences

As you weigh your decisions, you can’t forget about the tax consequences of eliminating a fund. Obviously, capital gains taxes don’t immediately affect your tax-deferred accounts. However, taxes are an important decision when you sell or reduce a position in a taxable account. While you have to pay attention to the tax burden, you should never let taxes overwhelm the decision-making process.

If a fund or individual security is showing extreme performance or has become too big in your portfolio, you shouldn’t hold onto it just because you are trying to avoid paying tax. Instead, come up with a strategy to reduce the risk and tax burden over a reasonable period of time. Clearly, this is an area where investment and tax professionals can be extremely helpful.

When I was chief investment officer for the North Carolina pension plan, we asked all of our money managers to evaluate our assets and make recommendations to improve our performance. Our international managers thought we needed more exposure to foreign markets. Our domestic managers advised us to increase our allocation to U.S. stocks. You can guess what the hedge fund, private equity, and real estate managers recommended.

We spent a couple of hours in the Treasurer’s Office leafing through the thick presentation books, which were filled with statistical models. It’s hard to believe that optimization models and Monte Carlo simulations, which I discussed in my last column, could produce roars of laughter. We were amused by the self-serving advice.

As 2014 begins, it is worthwhile to review your portfolio or let your investment adviser conduct a review. Making changes in investment portfolios is expensive, so you and your adviser need to have very good reasons for making the modifications. If the reasoning doesn’t make sense to you, then perhaps it’s time to find a new adviser – or to simply do nothing.

Andrew Silton’s Meditations on Money columns can be found twice a month in The N&O’s Work&Money section. He is a retired money manager living in Chapel Hill. He was CIO for the North Carolina Retirement System from 2002 to 2005. He writes the blog

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