Economic Reflections


by | Sep 14, 2020 | Economic Reflections

My family recently had the opportunity to go on a guided fishing trip at Blue Mesa Reservoir. Spanning 20 miles in Gunnison County, Blue Mesa is Colorado’s largest body of water and one of the largest high altitude bodies of water in the United States. It is also home to the largest lake trout fishery in Colorado and the largest kokanee salmon fishery in the United States. We had hopes of taking a few salmon home for dinner. Although I have a modest amount of fishing expertise, I have no experience specific to fishing in this large body of water. Fortunately, our guide did.

Ryan grew up fishing the reservoir and recently graduated from Western Colorado University a few miles away with a degree in Recreation and Outdoor Education. His boat was well equipped to fish at multiple depths with several tools. Using his expertise and these tools, we were able to have six lines in the water while trolling (moving at a slow speed) for salmon and trout. Using eight-pound lead balls, two lines were set with downriggers which kept the lures at 25 to 35 feet deep, two lines were sent out wide on either side of the boat with weighted fishing lines so the lures were between eight and 15 feet deep, and two lines were sent out behind the boat with lightweight fishing lines so the lures were between two and five feet deep. Throughout the trip, Ryan maintained focus on our targets, kept lines in the water at various depths, and changed lures based on water conditions and “feedback” from the fish.

With such an experienced guide, a well-balanced approach, and ongoing maintenance, we thought the salmon did not stand a chance. Unfortunately, the timing of our trip was not ideal. In the late summer and early fall, the salmon leave the reservoir and start to head up the Gunnison River to spawn. Although we did not catch any salmon, our efforts yielded five rainbow trout, two of which we took home for a hearty meal.

Much like fishing, building and maintaining an effective investment portfolio requires research, preparation, identifying targets, staying invested, and adjusting as conditions warrant. In caring for the assets of the clients we serve, Syntrinsic views asset allocation as a critical part of the investment process. Much time is spent evaluating the risk and return expectations of each asset class and then constructing portfolios focused on the needs and goals of each client. The resulting portfolios are well balanced in terms of risk, return expectations, time horizon, and liquidity needs.

While developing an appropriate asset allocation is a key component of a successful investment strategy, monitoring and maintaining the asset allocation is just as important. Effective asset allocation drives long-term performance1, but this requires more than a plan – it requires regular maintenance.

Keep your line in the water

After identifying the appropriate asset allocation, staying invested is a critical part of the maintenance process. As a child, my father often reminded me, “you definitely will not catch a fish unless your line is in the water.” Similarly, it has been said that investing is not about timing the market, it is about time in the market. Many studies have shown that missing just a few of the best days in the market can significantly impact long-term performance.2 Rather than trying to predict highs and lows, it is important to stay invested throughout. During times of market volatility, this can be very difficult, however, it is important to remember that the permanent loss of capital associated with selling at inopportune times can be far more damaging than short-term spikes in market volatility. Many cases of permanent loss of capital are self-inflicted by buying or selling as an emotional response to the latest headlines. The past decade has been unsettling for many investors. The recession of 2008–2009 made some investors so anxious that they stopped adding to their portfolios — or even withdrew their money at market lows, locking in losses. Unfortunately, this is also true for the recent downturn in the spring of 2020. Trying to avoid the worst drops often means missing the opportunity for gains (and frequently investors get out too late to avoid the worst of the decline). Despite the current market volatility, it is important to resist the urge to sell and move to cash. Short-term dips in the market are to be expected over decades-long (or longer) investment horizons.

Stay focused on the target

A key part of the portfolio construction process is identifying appropriate asset class targets. These targets are typically outlined in an investor’s Investment Policy Statement (IPS). Over time, some asset classes will perform better than others, causing the portfolio to deviate from the asset class targets. Rebalancing is the process of buying and selling portions of investment portfolios to reset the weight of each asset class to its target. This enables investors to maintain a consistent asset allocation through changing market conditions. Ignoring rebalancing entirely can change the risk profile of the portfolio significantly and means that important diversification decisions are effectively undone.

When implementing a rebalancing strategy, there are several issues to consider:

  • Is there sufficient liquidity?
  • Are the asset allocation targets still appropriate?
  • Are there constraints from rebalancing due to illiquid investments in the portfolio?
  • Are there transaction costs to consider?

An experienced advisor can help guide investors through these issues. Rebalancing can be contrarian in nature, and behavioral finance research indicates that this process will likely cause some discomfort in the moment.3 While it seems like a given that a rebalancing policy should be implemented in volatile markets, the execution often gets overlooked and undervalued. The psychological challenges around implementation often lead investors to ignore or change their plan. This can cause investors to miss opportunities to add value to their portfolios—especially during periods of elevated market volatility. It may seem counterintuitive to sell an investment that has been outperforming and buy an investment that has been underperforming, but past performance does not predict future results.

There are several strategies for rebalancing, but I will briefly discuss two of the most common. Threshold or tolerance band rebalancing sets a band (such as +/- 10%) around each asset class target. If the weighting of an asset class drifts beyond the band, it is a signal to realign the portfolio. If using this strategy, the bands should be identified in an investor’s IPS. This strategy pays close attention to the amount of portfolio drift.

Calendar rebalancing is one of the simpler approaches and involves adjusting the asset allocation back to the targets at regular intervals such as monthly, quarterly, or annually. This strategy ignores how much the portfolio has drifted from its targets but is easy to implement. If utilizing a calendar rebalancing method, quarterly intervals are generally preferred as shorter intervals can incur high transaction costs, as longer intervals may allow for too much portfolio drift. The ideal process of rebalancing must be considered in the context of an investor’s liquidity needs, time horizon, and transaction costs. In a period of normal volatility, rebalancing a portfolio one or two times a year can often strike the proper balance, but rebalancing with greater frequency may be necessary during sharp up or down moves in markets.

Rebalancing does not always involve selling one asset class and buying into another. Often, opportunities exist to rebalance when cashflow events occur. If withdrawals from the portfolio are needed, this can be an opportunity to decrease the percentage in an asset class that is overweight relative to the target. Likewise, when there are new investments into the portfolio, strategically adding to asset classes that are underweight can accomplish the rebalancing process.

The Syntrinsic Way

Our process around asset allocation and rebalancing is supported by our Investment Philosophy. We typically use tolerance band rebalancing as our core process and utilize additional opportunities to rebalance when there are cashflow events, or changes to investment managers or asset allocation targets. Two of the four pillars of our Investment Philosophy speak directly to the need to maintain a fully invested, well-balanced portfolio.

Time is of the Essence:  in fishing, patience can yield results. Syntrinsic recognizes that investors often destroy capital when they try to time the markets. We are patient investors.

Objectivity Over Emotion: On our fishing trip we were attracted by the prospect of kokanee salmon but drawing on knowledge and experience, our guide adjusted, and we were rewarded with several rainbow trout. While on the lookout for unexpected trends and risks, Syntrinsic’s data-driven process keeps us from getting distracted by emotional headlines or less meaningful data points.

Our experienced fishing guide showed the value of research, preparation, identifying targets, and adjusting as needed. Similarly, we are pleased to provide experienced “guiding” services for our clients who serve the communities in which we live.

  1. Roger G. Ibbotson and Paul Kaplan “Does Asset Allocation Policy Explain 40%, 90% or 100% of Performance?” (2001)
  2. The Capital Group “Time, Not Timing, Is What Matters” 2018
  3. Morningstar, Adam Millson and Jason Kephart, CFA “Here’s Why You Should Rebalance (Again)” (March 26, 2020)