Kenneth Solow has built an impressive investment record over nearly three decades by challenging conventional wisdom about how to construct portfolios, manage risk and move money among various asset classes. The co-founder and chief investment officer of Pinnacle Advisory Group in Columbia, Md., decries the state of training for financial advisers, who are still being taught methods based on largely discredited investment theories. And he continues to assail sacred cows such as buy-and-hold and passive investing. His 2009 book, Buy and Hold is Dead (Again), is not for the sit-back-and-wait-out-the-storm crowd.
What's wrong with the way financial advisers approach their task?
Look at the class work required to become even a chartered financial analyst - they completely ignore how macro issues affect asset class performance. Most people are shocked to find out that the average adviser has no clue what all those things mean to performance. And it gets worse: The average adviser would deny that it's important. Because if you believe in efficient markets, it's like the U.S. Fed [saying] "We can't identify asset bubbles when they occur. We can only clean up the mess afterward." Pure and utter bull ... As advisers and investors, we all have to be in the business of identifying what are cheap assets and what are expensive assets.
In the debate about passive versus active portfolio management, it's obvious where you side.
It may surprise you to know that I'm fairly agnostic about it. In the media and among investors, the debate is about whether you are better off to use an index fund to own an asset class versus an active manager to own the asset class. That's what everybody has been talking about for 40 years. Can the average active manager outperform a style-constrained index? Can a large-growth manager outperform the large-growth index? Given my choice, frankly, I would start with the index.
Yet you are widely known as an active manager.
People looking for a study to prove conclusively that active management really works aren't going to find it, because the debate is a very constrained one about whether index funds are better than mutual funds. Which is the wrong debate. If Pinnacle's people decide they like small-caps or specific sectors, I have the choice of buying an ETF to own a sector or an actively managed fund whose manager specializes in that sector. That's an important decision for us. But it's not the most important decision.
The most important decision is whether I want to own that sector at all. That's what we mean by active management. It's what we call tactical asset allocation. To me, an index fund is just one way of capturing the performance of an asset class. The active management comes in our decision on whether we should own the asset class.
Pension funds and other institutional investors have been scrambling to recoup heavy losses stemming from the global market meltdown. What's your assessment of the way they have gone about it?
The ones that I've reviewed would be characterized as growth portfolios. Looking at the Maryland [state]pension plan, fixed-income targets, including cash, are about 25 per cent of the portfolio. In the old days, I guarantee you that the 75 per cent in risk assets would have been in stocks and maybe real estate. But if you look today, you're going to find half of those risk assets will be in hedge funds, private equity and all these other alternatives.
Traditional asset classes are being dramatically underweighted. They're all hoping and praying that alternative asset classes - for whatever reason that you care to assign to it, whether it's the liquidity premium, leverage, or manager quality - will outperform.
What about the individual investor?
I'm concerned about what your readers think is the way to build a portfolio and then deal with volatile markets. In my experience, [investors]probably don't understand what it means. In many cases, they build a portfolio that has 30 stocks and spend their time wondering if Jim Cramer likes their stocks or not.
I don't think investors should be actively managing or tactically managing a portfolio. More mischief would be caused by the average person trying to market-time asset classes than would be solved by telling them they ought to do it. I'm trying to be responsible here.
Yet you argue that this is a terrific time to be a small investor.
Technology has made this the best possible time to be a retail investor. It's extraordinary. You have these marketplaces where a custodian will hold on to the securities for you and allow you thousands and thousands of choices in terms of asset classes. But individuals don't really have a good understanding of what it is they're really trying to do with their capital.
[After 27 years in the business]I have finally reached the conclusion that if individuals have wealth and can afford to, they shouldn't manage their own money. They should go through the rigorous, very difficult process of finding an adviser who knows what they're doing with tactical asset allocation. We're so early in the process of the industry learning about this that it's not an easy thing to do.
Title: Founding partner, chief investment officer, Pinnacle Advisory Group, Columbia, Md.
Personal: Married, with two children. Graduate of Towson University, Baltimore.
*Patience is not an investment strategy.
*There's no way to actively manage a portfolio and not make mistakes.
*I don't need to be right all the time. I just need to make fewer mistakes than the consensus and I will win.