Horizon Kinetics: indexation and asset allocation models are broken

Investors now face questions they haven’t had to consider for decades.  Until this past year, the entrenched basketof-securities approach to investing meant one didn’t have to think, one just bought the recommended asset classes.  That approach is now in disarray.  It depended on a simplistic presumption that the prior 20 or 40 years of daily price data represented normality.  It couldn’t contemplate a change in those presumptions.  History is a lot messier.  That data, it turns out, described an anomalous period, not a normative one. 

It should now be clear that indexation and asset allocation models – at least as practiced – can no longer be relied upon as having predictive value.  Bonds, for instance.  Over the past 20 years, after taxes, they returned only about 2%, annualized.  Even accepting the government’s CPI calculation that inflation averaged only 2.5%, that means bonds had a negative real return, a two-decade loss of purchasing power.  That was not supposed to happen (on the reasoning that it hadn’t happened before).  And that was during a period of relatively benign inflation.  ‘Benign’ is not the likely caption for the next 20 years.  Rationally, one must rethink one’s approach to bond investing.  One must rethink other presumptions about the standardized approach to investing.

~ Horizon Kinetics 2023 investor letter, January 4, 2023

Murray Stahl

Doug Casey on political diversification

Q: Baron Rothschild knew how to profit from the politically created chaos of the Napoleonic era. 

Today, how does an experienced speculator emerge wealthier through and after a crisis? 

Doug Casey: The most important thing is political diversification. 

Most people have all their assets, investments, and attention in the country where they live. 

That’s a mistake, as the Russians found out 100 years ago, the Germans found out in the 1930s and 40s, the Chinese in the 1950s, the Cubans in the 1960s, and the Vietnamese in the 1970s, just to name a few well-known examples.  Everybody in the backward countries of South America, Asia, and Africa gets an education in political, social, and economic chaos every few years when their government changes.  Americans should pay attention to how quickly things can change.  The spectre of Marxism is stalking the West. 

As great as the financial and economic risks are today, however, the biggest risks are political.  That’s why it’s very important to diversify politically and geographically if you can. 

In this coming decade, some speculators will make huge fortunes, but it won’t be easy since it’s cyclically time to eat the rich.  Governments are going to try to take what you make away from you.  Millions of people suffering from a serious decline in their standard of living are going to be envious and resentful.  It’s not going to be a good time to show off expensive toys; put the Lambo in the garage and leave it there.

~ Doug Casey, "Doug Casey on How You Can Think and Act Like a Professional Speculator," International Man, July 3, 2021

Battle of Waterloo

Warren Buffett on diversification

Wide diversification is only required when investors do not understand what they are doing.

~ Warren Buffett

Cathie Wood on Bitcoin as a portfolio diversifier

If you look at the correlation of Bitcoin's performance relative to any other asset class, it has the lowest correlation.  Meaning, if you buy some Bitcoin you will further diversify your portfolio and increase your returns with lower risk, right?  So that's why institutions look for that low correlation.  Bitcoin has it.  And so that's clear; we have 10 years of history now. 

~ Cathie Wood, "A typical day for Ark Invest's star stock picker Cathie Wood," Yahoo!Finance, 17:50 mark, February 6, 2021

(Bitcoin closed at $39,267 on Feb. 6.)

Marc Faber: "The Chinese economy will be the size of Europe and America combined"

If I were an American, I would hold some assets outside America and I would not only listen to the "China bashers," but also try to understand that the Chinese economy will be the size of Europe and America combined...  And whether you like the Chinese or not, and whether you're racist or not, I think that portfolios will have to own some assets in China, whether it's real estate or stocks or bonds.  In all the global indices, China is way underweight.  I have many friends - they invest in China - and they find world class companies.  Nobody can deny that Netease or Alibaba or Tencent are not world class companies.  There are also industrial companies.  There are also beverage companies that are world class. When Grant [Williams] asked the question, "How do you protect yourself?", I think you need an international diversification.  I think China is an option. 

~ Marc Faber, "The End Game Ep. 8 - Dr. Marc Faber," The Grant Williams Podcast, 1:03:50 mark, October 7, 2020

Mark Urquhart on passive investing

The notion that equity indexes are somehow risk-free states has to my mind always been a dangerous fallacy which has been amplified by the rise of passive investing. Actually, all three of the significant market crises which my career has contained — technology, media and telecoms (TMT), the financial crisis and now the coronavirus — have been linked by so much damage being done to particular parts of the index that it demolishes the thesis that index investing can diversify away such risk.

~ Mark Urquhart, money manager at Baillie Gifford in Edinburgh, Scotland, "Opinion: The hidden risk in your S&P 500 index fund," MarketWatch.com, July 17, 2020

BlackRock strategist: bonds act as a shock absorber (2019)

Even with low yields, bonds play a really important role in providing a cushion against shocks in other parts of the market.

~ Mike Pyle, global chief investment strategist, BlackRock Investment Instiute, as quoted in Barron's, "The Trend Isn't a Friend: Bond funds are hot, but the yield-hungry should be wary," August 3, 2019

Christopher Ailman on the limits of diversification this cycle

For the past 30 to 40 years, the common wisdom has been that diversification reduces risk, and the main diversifying asset has been fixed income. With interest rates in the U.S. at 200-year lows and negative interest rates elsewhere in the world, you can’t say fixed income is a diversifier.

~ Christopher Ailman, chief investment officer of CalSTRS, "The Trendsetter: Christopher Ailman of CalSTRS," Barron's, September 23, 2017

Philip Fisher on portfolio size

Usually, a very long list of securities is not a sign of the brilliant investor, but of one who is unsure of himself.

~ Philip Fisher, stock legend, "Five More Don'ts for Investors", Common Stocks and Uncommon Profits, 1958

Chinese entrepreneur Zhang Xin on diversification

When it comes to business and relationships, I don't buy this idea of diversification. It neglects comparative advantage. The best way to lower risk is to specialize: Put the things you love into one portfolio.

Zhang Xin, co-founder and CEO, Soho China, "'The Best Advice I Ever Got'," Fortune, May 12, 2008

(Zhang, a woman, is one of Beijing's most successful property developers and a product of Western training - Cambridge, Goldman Sachs. Her husband, Pay Shiyi, focuses on sales while she handles construction.)

XL Capital Assurance on the importance of diversification to the performance of CDOs

Although CDOs are now 14 or so years old, structural innovation continues unabated and more innovation usually translates into more involvement by the monoline insurers. While it is important to have a strong structure, perhaps nothing helps a CDO transaction, or a portfolio of CDO investments, more than diversification. The best of managers cannot consistently beat the market or avoid defaults. Many CDO investors know that concentrations are little more than expensive wagers. If there is one lesson to be learnt from the performance of CDOs of various cohorts and types, it is this: Diversify.

This lesson has not been lost on the monolines.

~ Iftikhar Hyder, XL Capital Assurance Inc., "Collateralised Debt Obligations and the Role of Monoline Insurers," September 24, 2002