February 3, 2009
One consequence of thinking in a structural way about investing is to pay greater attention to the portfolio as a whole than to its individual components. It also allows us to compensate for some of the regular and irrational errors that researchers in behavioral finance have observed being consistently committed by investors. I will have more to say about this in future newsletters.
At this point you ought to know where I stand: My sympathies are with the neoclassical financial theorists. After all, I was educated in finance at the University of Chicago. But I have been an investment practitioner for more than twenty years, and I temper theory with experience. And in handling the portfolios of individuals, I am tilling fields where the theorists, in their ideal and perfect shoes, have feared to tread (at least until the last few years) but investment advisers have been laboring throughout modern history. This is why I emphasize the importance of the structuring of portfolios. You will seldom find me bloviating on the performance of individual stocks. Even Benjamin Graham, writing before the advent of modern portfolio theory, asserted that the concept underlying his approach to security selection, which he named “margin of safety,” is logically connected to the principle of diversification—in other words, portfolio construction.
You may think that I am addressing esoteric disagreements among investment practitioners that have little relevance for your portfolio. But these ideas have practical consequences. There are both subtle and broad disagreements among investment practitioners, and some of these most assuredly have relevance for your own investments. John Maynard Keynes famously wrote that “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” Practical investors who fail to think systematically about what they do are usually the slaves, too, of some defunct investment commentator.
And why am I telling you this, and what are the practical consequences for you, the investor?
If all that mattered in investing were the selection of winning stocks, all of us should be holding the same set of stocks. All our investments would be alike. But they are not, and they should not be. What matters most is the structuring of the portfolio. And the portfolio should be structured to suit the investor. Investment managers are charged with the management each portfolio to fit the particular objectives and circumstances of each client.
Adam Jared Apt, CFA, is a financial advisor and the owner of Peabody River Asset Management, based in Cambridge, MA.
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