A friend of mine dropped by my office the other day. After charming his way past Pat, who guards the gates at our place, he strolled into my office. I looked up and smiled, “Hey, Joe. To what do I owe the pleasure?”
“Buenos dias. Como estas?” Until that moment I did not know that Joe could speak Spanish at all. Not to be outdone, I replied, “Asi, asi, y tu?”
This is when I was enlightened to the extent of Joe’s knowledge of the romance language.
“We’re going to have to start speaking English because I don’t have a clue what you just said.” It was fine with me because I couldn’t go much further either.
“What’s up?” I asked again. Joe said, “You know that investment committee I agreed to serve on last year? Well, we just got through meeting with our consultant on making some changes and I couldn’t have learned less if he was speaking Spanish the whole time. What has happened to our industry? I was a broker back in the ‘80s and I thought I knew what was going on in the investment world, but as the song says, ‘the times, they are a changing’.”
Joe is right. The times are changing, especially in the investment world.
It seems like forever, but it wasn’t that long ago when I passed my Series 7 exam and became licensed to trade securities in 1985. Back then the mutual fund industry was still a struggling cottage shop group of funds and the king of the jungle was the individual stock. We spent hours reading research reports and balance sheets looking for the next great stock to buy. The market was smaller, there were less individual investors and the opportunity to take advantage of inefficiency in the market was more prevalent.
After 20 years, I think we have grown to a different level. It is much harder to determine, recognize and act upon individual investments than in the past. There are too many professionals doing just that for the 15,000 or so mutual funds that implement high level investment strategies for anyone to think they can be successful doing it part time. And part time means investors who have a real job, as well as people in the industry who have to spend most of their time on something other than researching stocks and bonds.
One of my closet friends in the business is a money manager who spends all day every day watching and analyzing the stocks in his universe. He is smart, dedicated and loves to work. The average guy, understandably, has a hard time competing with that. So, we have progressed as an industry, from trying to pick the right investment to trying to pick the right mutual fund or money manager.
Lost in translation
That’s where this language barrier comes into play. For years our industry has taught the language of the individual investment, and the average investor has become conversationally fluent. He/she can talk about P/E ratios and ex-dividend dates all day long.
The problem comes in trying to use that language to pick your next mutual fund manager.
Past performance is critical when looking at an individual stock; it is less so when determining the appropriate mutual fund. Low correlation is rarely considered when looking at an individual security however, it is crucial when developing an asset allocation model. Alpha, beta and standard deviation have taken the place of P/E ratios, dividend yields and 12-month projected earnings per share.
There were some investment committees that looked at investments this way back in the 1980s, but not many. Even though more investors speak the language of modern portfolio theory than ever before, the industry seems to fall woefully short on interpreters and teachers. This leaves many investors reading a language they don’t understand and searching for words they are familiar with in order to make a decision. It can be a frustrating process and will leave some investors with portfolios that don’t work as planned.
If you want to learn more about the language of portfolio constructions and analysis, plug “Modern Portfolio Theory” into your search engine and start learning.
Harry Markowitz brought Modern Portfolio Theory to the world in 1953. It’s probably not as modern as you think. He won the Nobel Prize for his work and it is considered the preferred framework for portfolio construction and analysis.
Start learning the language because the more you learn, the more confidence you will have in your ability to meet your goals. Vaya con dios.
Contact MBJ contributing columnist Scott Reed, CIMA, CWA, AIF, of Hilliard Lyons, member NYSE & SIPC, in Tupelo at firstname.lastname@example.org. Hilliard Lyons does not offer tax advice. Please consult your tax advisor before making any decision that may affect your tax situation.