Pie In The Sky

Christopher Columbus discovered that the world is round. Sir Isaac Newton established the theory of gravity. Albert Einstein founded the theory of relativity. Dr. Harry Markowitz created modern portfolio theory (MPT). Each of these are long known immutable truths that transcend all time….well, maybe not that last one.

Ever since I earned my CFP designation in the mid-80, I have viewed the investing world through the lens of Modern Portfolio Theory. It was as true and evident as the earth being round or gravity causing the apple to fall to the ground. Depending on one’s appetite for risk and time horizon, investors could fit nicely into one in a set of asset allocation pie charts that span the most conservative to the most aggressive. And other than rebalancing the portfolio once a year to fit back into the chosen pie chart, you could pretty much forget about it and let your asset allocation do it’s magic. Buy and hold. Clean, easy and to the satisfaction of Chief Compliance Officers, suitable. But as the past decade has shown, it’s not that easy anymore.

A year ago, I wrote a blog post that was inspired by the movie “Wall Street”, both the 80’s original and the recent sequel about the greed and excesses in the business. I’m often surprised and flattered that anyone reads my stuff. My own wife, a CFP, doesn’t even read it! But I was contacted by a guy who had read this particular post and could relate with it. He called and wanted to meet while on a visit to Dallas. Like me, he had lived the excesses of the dot.com bubble in NYC and was even the poster boy for these excesses in a New York Observer article about stockbrokers. It was not exactly the kind of article you would want as reprints for your clients and prospects. Anyway, we shared war stories and have kept in touch. And as I have shared my experiences with being in NYC during 9/11, Lee had a similar life changing experience and packed up his bags 4 months later to start a new back home in New Mexico.  Lee Munson is about as bright as they come in the business with real world experience, wit and a bit of irreverence that makes him very interesting to talk with. The reason I bring him up is that I just finished his new book called “Rigged Money” which debunks some long standing immutable truths in the business, including Modern Portfolio Theory. Similar to a reformed smoker, Lee is a reformed stockbroker with the same level of zeal and contempt for his former lifestyle. Lee now runs a successful fee only RIA firm called Portfolio LLC http://www.portfoliollc.com/ and is a regular “talking head” on CNBC’s Kudlow. While many of us in the business, myself included, have been questioning the old theories that we’ve long accepted as law in the business, reading Lee’s book, I am convinced that all the assumptions and basic “truths” that went into what we were taught growing up in the business have changed.

With chapters titled “Buy and Hope-The Scam” and “Lie of the Pie” you can imagine how it positions against the old school of thought. But it caused me to think how much the rules really have changed. The products, the tools and the speed at which information moves and trades are made today bear little resemblance to what we were dealing with just a decade ago. In 2000 there were 106 ETF’s. Today it’s pushing towards 5,000 with over 200 introduced this month alone. When Markowitz came out with MPT in the 50’s, there were not even 100 mutual funds. Today there are about 7,500 funds. This is not to mention the nano seconds that high frequency computer trades dart in and out of positions, the great impact options, derivatives and hedge funds play today and the multiple world markets that drive the US financial business all day and night. What correlated and non-correlated assets were a decade ago no longer holds true today. It's not so much MPT being dated (it's tough for me to shake the religion!) as much as the way the industry has applied it. The rules have changed.  Asset classes act differently than before. The simple set of pie charts that seemed to work into the 90’s are now more like a pie in the sky; something good that is unlikely to happen.

So now what do we do?...become day traders and market timers? No; doesn’t work and don’t have the time for it. What it does tell me though is that the investor can no longer rely on his or her “financial professional” to address their portfolio through a simplistic and outdated set of pie charts to recommend the hottest mutual fund du jour that the wholesaler told them to sell during a free lunch. I think we need now more than ever to rely on professional money managers like Lee who spend their entire being studying and thinking about this stuff all day, every day. I really don’t think an advisor can prospect, service and interact with their clients while at the same time being a successful full time money manager. This also tells me that the business models that worked up into the 90’s no longer work, yet they still exist. You cannot successfully be a one man band in this business anymore. You have to be part of a team and a larger organizational infrastructure that offloads the administrivia and compliance work as well as turning the investment management to a pro while the advisor takes time to….well, advise.

The speed of change is getting faster and faster. It is estimated this speed doubles every two years. While some may be thinking, “Stop the world, I wanna get off!”, others will adapt and survive. It’s those who adapt to change who will thrive in the future. Regulations and regulators are changing. Products and technology are changing and what were decade long tenets and truths in the business have been turned on their head. The question is, has your business process and business model changed with it? As we prepare for the coming year setting goals, budgets and business plans, this issue is more important now than ever. The coming year will reward those who adapt and bury those who are stuck with their heads buried in the status quo.

“The individuals who will succeed and flourish will also be masters of change: adept at reorienting their own and others’ activities in untried directions to bring about higher levels of achievement. They will be able to acquire and use power to produce innovation”