The Third Dimension
Beacon Pointe Advisors
December 12, 2011
The Third Dimension
In the world of investing, a discussion of both potential risk and potential reward is crucial. Often, the available investment options are plotted on two-dimensional graphs (historical or expected return vs. standard deviation); the analysis may be focused on risk-adjusted performance measures such as Sharpe Ratio, Alpha, or Information Ratio; and best/worst case scenarios (generated by a Monte Carlo simulation) are utilized to highlight the potential gain or loss for investors in extreme market environments. These various analytical tools are instrumental in indentifying the investor's risk tolerance, designing a target asset allocation in line with the stated return objectives given the risk constraints, and setting realistic expectations about the investment experience.
Frequently overlooked is the third dimension of the analysis -- time. Beacon Pointe has stressed the importance of a long-term investment horizon in many of our past client letters. We strongly believe that our long-term focus and discipline allow us to stay the course, while others chase performance or swing from one extreme camp (bear) to another (bull). As we have argued in the past, extrapolating a current trend -- be it positive or negative -- into the future is a dangerous way to formulate one's investment strategy. An especially strong month of market performance (like October 2011) offers more noise than real information about the future direction of major indices. Similarly, a period of short-term weakness does not necessarily spell the beginning of another major downturn. Today, there is certainly no shortage of reasons to worry. The ailing Eurozone and a divided Washington, DC continue to test an already frail market sentiment. These are two worthy candidates for addition to the list of possible reasons to stay on the sidelines. The list below and the accompanying graph on the next page, courtesy of GE Asset Management, highlight the importance of a long-term mindset. Despite the constant macroeconomic, political, and natural disaster headwinds, equities have gained 9.6% per year from 1/1/26 to 12/31/10.
Of course, time is a matter of perspective. The appropriate time horizon varies among clients and may be quite different for institutional versus private clients. These differences should be addressed at the asset allocation stage in conjunction with a thorough evaluation of each client's circumstances, investment objectives, spending needs, and risk tolerance. Finally, the selection of investment managers should also take into account the specific goals and needs of each client. While Beacon Pointe's recommended managers are typically long-term investors, they are active managers with strict buy and sell disciplines. As such, they adjust client portfolios to protect against risk or take advantage of investment opportunities presented by the market.
The uncertainty generated by the ongoing sovereign debt crisis in Europe and policymakers' deadlock in the U.S. is likely to persist for a while, but it should not drive long-term investors out of the market. We believe it is prudent to stay focused on the third dimension -- time -- and to remain committed to one's long-term investment strategy with an emphasis on diversification, capital preservation, and careful manager research and selection.
Please feel free to call Beacon Pointe at 949-718-1600 should you need additional information or have any questions.
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