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The Alhambra View

I have had the pleasure of working with my new colleague Patrick Manning helping him reformulate our strategic (passive) portfolios for future clients.  The exchange of ideas with a 40 year Wall Street veteran has been extremely satisfying.  Pat has shared many insights picked up over the years and I have been able to relate to him many of the distinguishing characteristics of Alhambra.  The process has helped solidify some concepts I would like to share with our readers.

At the beginning of Alhambra there was Joseph Calhoun III.  Joe’s investment experience and in depth study of economics is the genesis of what I often refer to as the Alhambra view of the world. Alhambra’s views are derived from macroeconomic principles and statistical studies.  They determine why, where and when we invest.  The perspective starts with a firm grasp of macro-economics, a belief in the teachings of the Austrian School of thought and an understanding, yet skeptical view, of what policy enactors, with beliefs contrary to ours, are attempting to accomplish.  The philosophy is at times very broad; Adam Smith’s belief that the combination of self-interest and free markets leads to innovation and economic well-being.  The Alhambra view can be narrow; there is temporary, artificial demand for long term, low risk fixed income securities because of the central bank’s current policy to print currency and purchase treasury bonds.   I, along with my other colleagues, gravitated to these views.  Exercises such as strategizing with Mr. Manning on a sound investing platform produce prideful confirmation of these beliefs.  Our view has academic merit, has been empirically shown to work; and, to be crude, it just makes sense.

At Alhambra, we hold true to these principles as we invest for and with our clients.  We believe our investment philosophy and process give individuals the best chance of reaching their long term financial goals; this model parallels the strategies of many large endowments and foundations.

Here is how it works in practice.

Our philosophy:

A client entrusts to us his/her financial assets to investment on their behalf.  We do not indiscriminately allocate their wealth (ie. 60/40 stocks and bonds).  Exposure to certain economic risks and rewards are purposeful.  We allocate capital where it is demanded; and, we allocate where and when the expectations for return and risk are favorable.

A top down approach:

Man, thus an economy, is self-interested and therefore innovative; progress is a principle.  Broad asset classes possess principled demand for capital resources which present desirable risk/return characteristics.  The ratios of these assets in a portfolio present desirable diversifying characteristics.  At this point we have developed the Alhambra view of the Normal Portfolio.

Fiat/floating currencies require the close scrutiny of a fluctuating benchmark for price.  Policy initiatives of influential institutions such as governments and central banks have implications for capital and capital allocation.  Man exhibits behavioral biases.  Marginal utility and the market forces of supply and demand in all areas of an economy have important consequences for capital.  Certain ideas and companies possess competitive market advantages.  Economic integration and segregation, especially among countries, have implication for capital.  From these broad macro themes we tactically alter the normal portfolio.

Our Process:

At Alhambra there are 4 tenets when consulting with a client and charting an investment strategy:

The level of overall portfolio risk for each unique client is of primary importance.  There are 2 perspectives to consider.

First, factors affecting the ability to take risk.

  • Current sources of income and whether it has correlation to the capital markets
  • Debt
  • Portfolio size and overall wealth
  • Spending and other unique liquidity needs (both short and long term)
  • Investment horizon(s): an investor often has multiple horizons
  • Investment goals and the relative importance of attaining these goals (ie home down payment v. an extravagant lifestyle)

Second, factors affecting the willingness to take risk.

  • Source of wealth
  • Psychological and behavioral considerations

The required and desired return appropriate for the client

  • Based upon the above assessment, together with tax, transfer of wealth, regulatory considerations and, potentially, other unique circumstances we derive the required/desired return appropriate for the client.

The most suitable asset allocation and investment style to help the client meet his/her goals

  • Based upon historical research, different classes of assets expose an investor to unique economic factors.  It then follows, from the academic research of modern portfolio theory, that each asset in a portfolio has its own unique set of statistical characteristics.  These metrics not only describe the return one expects from allocating capital to this asset, but also how the asset interacts with other assets in the portfolio.  The academically engineered portfolio, diversified across asset classes, has been shown to have lower volatility and produce higher returns per unit of risk than a portfolio not subject to such scrutiny.

** for purposes of full disclosure, data sets used to derive these statistical properties commonly date back to 1978.  They happen to coincide with bond yields falling from near 15% in late 1981 to their low levels today just below 3%.  Also, there are factors stemming from the full implementation of fiat currencies in the early 70’s producing the, seemingly, continual depreciation of the dollar.  Thirdly, there is empirical data showing a small cap bias, generally considered to be the result of information asymmetry and survivorship issues.  Therefore, the most efficient portfolio produced by the math is the combination of mostly small cap stocks with smaller allotments to long term bonds and commodities.  Our industry experience and research shows that these are important assets but leads us to reject this allocation in favor of a more practical portfolio just below the theoretical frontier.  There are some big name academics who have championed some of these ideas, but we do not find the full implications prudent or suitable.

  • Based upon client circumstances and preferences we then choose a particular style or combination of styles in which to implement the allocation.  We follow two general styles in investing client capital: Passive, indexed asset exposure with strategic rebalancing and Dynamic, tactical allocation with strategic rebalancing.

 Monitor, Adjust and Rebalance

  • The analysis of global economic data/events and psychological market biases help us create an assessment of real, artificial, permanent and temporary imbalances in the supply and demand for capital.  These findings help us first determine relative risk levels in markets.  Subsequently, they lead to strategic and tactical decisions to stay or alter the allocation of our clients’ capital resources.  A decision to rebalance back to the target allocation, allocate capital between economic assets or sectors, or merely stay the course takes into consideration both the impact to expected risk and return of the decision, as well as, the costs involved to implement .
  • Changes in client circumstances can result in strategy alterations.

It was my intention to produce a series of pieces on the case for such assets as large cap stocks, small cap value stocks, commodities and real estate in one’s investment plan; this will be my focus in upcoming editions.  For this edition, I felt compelled to relate some background on the principles which form the basis for these allocations.  As fiduciaries, the custody of our clients’ assets is a profound honor and responsibility.  To write a piece telling you why we do something before relating our fore-thought, I felt, was putting the proverbial cart before the horse. I hope this helps clients and future clients to assess our fundamental approach to investing.

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Douglas R. Terry, CFA is reachable at dterry@alhambrapartners.com