TDI Podcast: Big Changes Coming (#988)

26:12Looking at where the development of a particular trend may be happening and whether or not you should have it in your portfolio or whether a particular trend is ending and maybe you shouldn't have that in your portfolio. When I say a trend, I'm not talking about a two month, three month. I'm talking about a multi-year trend that may be changing. One of the things that we did for many years was we looked at the growth and value side. And for the last two years, at least, we have been value-oriented a little bit, a little bit of a tilt, particularly at our large cap, even as it seemed that growth in tech was outperforming.

26:43Boy, the last 12 months, maybe 18 months, the outperformance by value has been astonishing. That has really helped portfolios do extremely well. And when you look at the addition of things like emerging markets and dollar softer trades, it has been really something that has been a game changer when it comes to portfolios. And that is exactly why we're working right now. Right now, right at this moment at HQ or at H &C, better put, Horowitz Company here, we've spent, I would say, the better part of a week or so kind of reimagining what our client portfolio should look like going into the end of the year and looking at the opportunities that seem pretty obvious that we uncovered and think that will be beneficial for the portfolios.

27:41And I expect that probably, probably, we're going to see more changes for portfolios as we get towards the end of the year. I think from everything that we're seeing, the opportunities are just there. And our guest probably today is going to fit perfectly into this conversation because we're going to get deeper. I have a lot of questions on my list to ask him into asset allocation, where the opportunities may be changing, how investors should be thinking about portfolio construction from here. So let's get into it. Before we do that, let's talk about interactive brokers because we know, I know, you know, you research your investments, you analyze markets, but have you researched your broker?

28:29For the past three years, interactive brokers' individual clients averaged a 24.3 % annual return, beating the S &P 500. Lower costs, competitive rates, and access to over 170 global markets help investors keep more of what they earn. The broker you choose matters. Interactive Brokers, member SIPC. Learn more at ibkr.com slash performance. Visit ibkr.com slash performance. Now, let's bring on our guest today. I want to talk about Tom Nelson. He's a good friend of mine, by the way. I spend a lot of time with him. We actually have dinner a lot. We go on the boat. We do a lot of stuff. But he is a treasure trove of information.

29:17I mean, this is one smart cookie. I'm talking about wicked smart kind of guy. He's a senior vice president and head of asset allocation portfolio management for Franklin Templeton Investment Solutions. He's a member of the Investment Strategy and Research Committee. He's also a portfolio manager of a number of funds offered for sale in various jurisdictions. For example, he is the lead portfolio manager for Franklin Next Step Fund Series, the Franklin VolSmart Allocation VIP Fund, and numerous model portfolios. He's also a portfolio manager of the Franklin LifeSmart Retirement, and the list goes on.

29:53He's been with Franklin Templeton since 2007. He's committed. He also co-founded the firm's Quantitative Research Services Group upon joining the company. And like I said, just an extreme treasure and a jewel and someone who I respect greatly. And I'm glad to have him on. I'm thrilled, actually. And we are very lucky to have him. So let's get into that conversation. I got a lot of questions for Tom. And Tom Nelson, it's great to have you back. of course, the whiz kid of Franklin, and appreciate you coming aboard again and discussing all things related to investing. Thank you for having me. Yeah.

30:34Can I call you the whiz kid of Franklin? You have such a young face. That's perfectly fine. Yeah. So I want to talk about, I want to make this show a little bit about some evergreen ideas, like the education behind and information behind the recipes on how to create, how to cook, and particularly talking about, of course, portfolio logic. But before we do that, before we get into that, I want to talk about something that happened last week because I'm kind of fascinated what your thoughts are on this. We saw an interesting move by the Federi, Scott Besant, once again, getting involved in, I'll call it the manipulation of financial matters.

31:11Started with a few weeks ago when he worked with the yen dollar, trying to knock that down with a little bit of a notepad that was in full view of the cameras, mistakenly. And this week, or last week, actually, he did something where he started to increase the bond buying in the treasury market of the longer data maturities. Now, that immediately had an impact, not tremendous, but enough of an impact on the on the long bond yields. Is this a classic yield curve control or just another form of targeted quantitative easing in your opinion? Yeah, it's a little early to tell, but it's interesting.

32:03We were in the process of writing up a piece about yields and where they are today. And relative to the last couple of decades, both in the US and in other countries, Germany, Japan, the UK, France, et cetera. And maybe in hindsight, it was a little bit less of a surprise than what we should have expected because of some of the concerns that the bond market is basically giving in terms of where they're taking yields. and specifically around inflation, but probably more importantly, fiscal deficits, right? And certainly a desire from the administration from the top on down for lower interest rates.

32:55And this was, we think, the first, we'll see if there are more behind it, move to help alleviate some of the stress on the bond market, and particularly on the long end, right, 10 years now. Yeah. What's interesting because this is really not the domain of the Fed. The Fed really has no ability to impact. Well, they could do something that we're not aware of, but the traditional methodology that the Fed uses and the tools they have, they really don't have, their first impact is not on the long side, right? It's much more on the short end. The Fed funds are the shortest. Correct. So with the knowledge that Fed Chair Warsh has said, hey, bond market, do your thing.

33:34You show us what you want us to do. You make it happen and do the heavy lifting for us, which I thought was like, what? Are you challenging the bond market? I don't know if that's the best idea in the world. Yeah, yeah. Because we can have those vigilantes come back, right? And who are, seriously, who are the vigilantes? Do you know? Not by name, but, you know, it's your traditional large players within the fixed income marketplace, be they asset managers, pension funds, other central banks, et cetera. But they're kind of, I guess they have a name, but they're certainly faceless. So let's get into some of the portfolio design discussions.

34:21And I want to talk about asset allocation because you're the head of the asset allocation division and related to target dates and a bunch of things of that nature at Franklin Templeton. So you spend your time immersed in asset allocation process. It's funny, you and I probably talked about this, but when I first got involved in this notion of asset allocation, a la Harry Markowitz, a la William Sharp, right? A la Brinson B. Bauer Hood. You know, that kind of thought where I was using all sorts of methodologies and computer assisted modeling to come up with the efficient frontier, the perfect allocation.

35:07I'm like, oh, if I just put one more percent in commodities, look how it changes this whole, you know, the efficient frontier. And I would painstakingly do this to one day I woke up. I'm like, what am I doing? What am I? What is the point of all this? You know what I mean? I said, if I have 1 % there and it does that much more and it goes up by 20%, it's 20 basis points in a portfolio. You know what I'm saying? It was like, what was the point of all that? But things have evolved, right? Things have changed. And then again, there are those that still stick to the core principles utilizing things to develop this.

35:44But walk me through your asset allocation process. Let's start with a blank sheet of paper. and two questions I want to follow up there and I'll remind you if we don't get to it, but what are non-negotiable asset classes that make it into every or virtually every portfolio and why? Yeah, yeah. So the central idea I would say is that we really start with the objective and not the asset classes, right? So before deciding how much we want to put into equities or bonds or alternatives or just about anything else, you really need to understand what the portfolio is actually being asked to accomplish.

36:28So things that we will discuss with clients, first off, what's the money for? And that really gets the conversation going and helps to illuminate what the client needs. Things like what return does the investor require? And is that expressed in absolute terms or relative to a benchmark? What's the time horizon? What sort of liquidity is required and those two are connected to each other. What's the ability and the willingness to tolerate drawdowns? Those are often not the same, but it's important to know what sort of losses does the client actually allow and what sort of losses lead to uncomfortable conversations and a phone call from the client, right?

37:12Are there income requirements, liquidities, taxes, you know, other constraints. And only then do we move towards our capital market assumptions, kind of long-term risk of return expectations and portfolio construction, right? And so that brings us sort of towards the strategic asset allocation. I'd also emphasize that you're not really allocating amongst asset class labels these days. We're really focused on allocating amongst economic exposures, right? Equities, they provide growth and participation in corporate profitability. Government bonds, they'll provide income, liquidity, particularly when growth is the dominant concern, diversification as well.

37:58Credit provides contractual income, exposure to economic growth, but with very different characteristics than equities. Real assets, They can provide protection from inflation. Alternatives can give you differentiated return streams. Cash provides liquidity, if you will. And so once we've got that objective down, our long-term return expectations, those capital market assumptions, are the input, major input to our strategic asset allocation process, where the end result of that is a set of asset classes and weights that should represent the asset mix that best meets the portfolio objective. We call it a 10-year time horizon.

38:42And that's kind of our North Star. Around that, we will tend to tilt portfolios dynamically. And when I say dynamically, that's for us with a six to 12-month time horizon. And that's given the fact that asset class performance can kind of wax and wane, given where we are, for example, within an economic cycle. So the strategic asset allocation, that's more valuation oriented, as valuations can really get out of whack for a while and potentially for years, but it is a really good tool for making long-term allocation decisions. While the dynamic process, it's kind of centered around things like growth, inflation, policy, and then things like sentiment and positioning overall.

39:25So I want to talk about two things there. I want to talk about dynamic versus tactical. So just hold that and put a pin in that for a second. But I want to go back to your discussion about CAPM, the capital asset pricing model. Capital asset pricing model, that's something that a lot of people should really consider. And maybe if you don't have the tools as an individual investor to go out and do this. But first question on that, what is your time frame for that? Because the idea that when you look at capital asset pricing model. In other words, I think, could I dare say that what is the outlook for any various asset class over a period of time?

40:05And that's, for example, if I'm going to think that, well, rates are going higher, our capital asset pricing model on the bonds, I'm making this simplistic, but on the bonds, we're negative on those, for example, right? Or we think that the dollar is going to go down, therefore, we want to have maybe a plus sign on the commodity area. Yeah. What is your, what is your, but that could be 10 years, which is very hard to establish, right? Unless we just do historicals. It could be six months, one year. Do you do a multi-pronged approach to that? Yeah. Maybe we could say we use bifocal vision to, I work for Franklin Templeton.

40:46Ben Franklin presented the bifocal. Oh, I like what you did there. I'll play him off that a little bit. Yeah. Yeah. And kind of that long term strategic for us is about 10 years. It's kind of seven to 10. Generally, it's a 10 year investment time horizon. And that gets us kind of directing us towards the final objective throughout a full cycle. And then the dynamic is, like I mentioned, like six to 12 months in terms of time horizon. And, you know, if you were to think about the economy, you know, is economic growth, is it good? Is it bad? Is it getting better? Is it getting worse? And you can break things into different quadrants based upon that data.

41:29And there is very distinct and different returns, using history as a guide, for asset classes like equities, for example. You know, when things are good and getting better, you want to load up on risk. You want to have a little bit more equities there, right? When things are bad and getting worse, you want to be a lot more defensive. You want to reduce your equity exposure more and into more defensive assets like fixed income, particularly treasuries. And so we will tilt around our strategic allocation to get us to that objective more efficiently, if you will. And how much risk we ascribe. Yeah, go ahead.

42:08The tilt is the dynamic movements. They're the interim adjustments to your longer-term capital asset pricing model in, I don't want to say real time, because it's still 6 to 12 months, right? But that is like, well, we know that or we think that this asset class is going to do well over the next 10 years. However, right now may not be the time. So we're going to maybe minus 2 % from that, if it was a, I don't know, pick the number, on that quadrant and bring down our overall exposure in a shorter term basis. But the idea would be that eventually, even though you've got to zig out of the way of a car on the highway, you're eventually going to get back into the lane that you want to be in and readjust.

42:52Is that correct? Correct. Yeah. And the dynamic is one whereby, and again, depends upon client objectives and how broad of a mandate we have, all of a sudden you're not going to take a portfolio that is moderate level of risk and make it extraordinarily risky, nor are you going to make it completely defensive and conservative. And so it's really just trying to make sure that we're taking advantage of opportunities and trying to sidestep risks along the way. So now as an institutional manager, you have a set of guidelines, usually called something like an investment policy statement or an overarching, whatever you may call it, particularly for the fund, for that particular fund, for that particular strategy.

43:49So if you have, I'm just going to call it a target date, pick a year, moderate risk portfolio, you're going to have a certain set that's based on your capital asset pricing model. Then you may do some dynamic overlays on that. We're going to get to tactical in a second. Dynamic overlays on that for an interim plus or minus of an adjustment. But you have to stay within the parameters of a much bigger scope of allowable asset class variations and minimums and maximums, I assume. Much different than what an individual has where they could be like, well, I like that stock, make it 30 % of my portfolio.

44:31Correct. Yeah. And for example, if in the case of a moderate level of risk portfolio, that can be from a prospectus basis, we'll use the 60-40 example, 60 % equities, 40 % fixed income. You could potentially deviate plus or minus 10 % from those neutral or those strategic weights. So equities can be anywhere from 50 to 70 percent and bonds can be anywhere from from 30 to 50 percent. And, you know, the overall level of risk is not going to change dramatically. We could we could be adding or taking risk down a little bit. But at the end of the day, the portfolios, you know, overall risk level and characteristics are going to be quite similar, such that when when investors purchase, say, a mutual fund that we might manage.

45:26they're getting what they're expecting to get. Yeah. It's interesting because, you know, a lot of times, like I said, I used to spend this inordinate amount of time designing a portfolio, you know, moving a little bit here, moving a little bit there. But if you think about it for a second, a 10 % overweight into a position, and if that position outperforms by 10 % during the period, or just performs by 10 % for the period, That's only a 1 % bump on the portfolio itself. Right now, when you are institutional, let's be honest, when you're institutional and you're tracking benchmarks, that's a big number.

46:03Right? A 1 % benefit really can be, or a 1 % negative can be really detrimental. You know, if you let that go for too long of a period of time. But it's not the end of the world kind of stuff. Correct. For an individual. Yeah, we'll also measure how much active return we're generating per unit of active risk, right? And that's essentially your information ratio. So if we're taking 2 % active risk and we generate 2 % incremental return, that's an information ratio of one, which is quite solid. If we generate 2 % of incremental return, but on 10 % active risk, that's a much lower number and less impressive, of course.

46:49Right. I think, by the way, side note, information ratio is a terrible name for that. Just saying. Yeah. It should be like, you know, well, we have risk adjusted or whatever. Or it's like, it should be, you know, pure alpha. I know alphas are there already, but something else, information ratio is like, oh, what is it? Most people never, I am pretty much sure that most people listening right now have never, or most people have not ever heard of information ratio. But it's an important thing, it's an important tool when you're calculating things to look at risk adjusted performance on something.

47:23It's, you know, how different are you from your benchmark and how much return did you get from being different? Right. A lot of times you'll see, the manager will talk about betas, they'll talk about alphas, they'll talk about sharp ratios. All these things are extraordinarily important, in my opinion, when we really get down to brass tacks, when we're choosing mutual funds, when we're choosing advisors that we work with inside of our portfolios. Again, most investors, I think, unfortunately, are going for pure return. And I remember a time, do you remember the fund families back when, GT Global?

48:00Remember that name? Yeah. Yeah. GT Global, they were like all the rage. All the rage. They had the emerging market stuff. They had all this stuff that was like, wow, obviously not around anymore. I don't think they're around anymore. But they succumbed to the fact that they had this, well, how about Cathie Wood? You want to look at that? We look at certain funds that are flash in the pans. Investors chase them, stay too long, and then a lot of times get burned on the back end. That is not the way to construct a all-weather portfolio. You know, when one storm hits, it's all over. So are there any asset classes that you, well, before I do that, I'm going backwards again, sorry, because I have this thought.

48:45I want to talk about tactical. Tell me the difference. You don't necessarily have to be using tactical. I don't know how much you do with that. But tell me the difference between dynamic and tactical, or if maybe it's interchangeable. depends on who you ask um there there are a lot of folks that use those two interchangeably we would generally view tactical to be shorter term than dynamic so if dynamic is is six to 12 months in terms of time horizon, tactical might be in the one to three months, if you will. And we tend to focus a little bit longer in terms of horizon. But there are folks that will view that as tactical, you know, short term, if you will.

49:38We just tend to think of the difference, if there is a difference between tactical and dynamic as a difference in time horizon. Yeah, I like that. I think that's That's the answer I would put on it if I was to be asked that. And I think that's really important to understand because when people are looking at core asset allocation overlaid with some dynamic processes and then potentially tackle on top of that, that is, I think, a really good thing to look at. Because within the idea, when people talk about a 60-40 portfolio, it's like, oh, big yawn, right? People don't want to hear about that. They want to hear about the next biotech that's going to cure something.

50:19They're going to want to hear about the next AI that's a takeover or getting money from NVIDIA. But the idea with this is that actually asset allocation, I guess it would be called active asset allocation, not static. But active asset allocation actually could have a lot of components to look for opportunities in the very near term, midterm and long term. It kind of covers all bases. Correct. In a way. Yeah. And we're talking about asset classes almost every day. Right. So.

50:57Um, are there any, are there any, uh, is there anything when you, in the years you've been doing this, is there any particular asset classes that's a don't touch? And let's leave crypto out, let's leave crypto out of that for a second. Anything else? We, look, we, we try to cast a wide net and offer access to a broad swath of asset classes, right? I think at the end of the day, client constraints can dictate what asset classes are appropriate for investment in portfolio. So clients with a demand for high levels of liquidity, private investments are probably not like private equity and private capital.

51:44Private real estate are probably not appropriate for that type of a portfolio. Right. With such a short time horizon. So that would be one thing. We're less interested in categorically avoiding an asset class than avoiding risks that we can't easily price, that aren't adequately compensated for taking, or are, as I mentioned, inconsistent with client objectives. And so, you know, almost every asset can have a role at the right price in at the right time in portfolios. But we want to make sure that we're getting commensurate return. We are utilizing strategies that are tradable and appropriate for portfolios, are not overly complex without commensurate return for that complexity.

52:40We don't want leverage that's masquerading as diversification. Strategies where the historical return is dependent upon one economic regime is not a great strategy to be holding across a full economic cycle. And so it's really about making sure that we're utilizing what is appropriate for the given portfolio and the client objectives. Open-minded is what I'm hearing here. And the idea that you want to make sure that within the constraints of what is appropriate from an age-based time horizon, from a risk management, from a risk tolerance, that it's – these are the keys, right? So the thing is you don't put an 89-year-old into a private equity placement if they need income and they need liquidity.

53:31I'm just saying that probably doesn't make sense. I mean that's extreme, right? situation, all the private equity guys don't have a problem with that. And then likewise, maybe it's not necessarily appropriate, even though a client may say, if a client has no need for money, they're 30 years old, to put them in a stable value kind of money market situation, that doesn't make sense either for the block what they have. Going back to something you touched on, we talked about, I mentioned the word, but you You talked about it in a different way is this old name they would put on or title they would put on portfolios called the All Weather Portfolio.

54:16You know, that was a way to look at it that, you know, it's like an all weather tire. You could use it in the winter, the summer, the spring. It's fine. It's not defined by just one season. And I use my flower garden. You've probably heard me talk about this, where, you know, in Florida, if we plant impatience and it's summertime, they're dead. They'll bloom beautifully January through March or so. But if we have a whole flower garden that is dedicated just to impatience and it blooms and they look great in January through March, and then all of a sudden they're just stems, sticks and dirt the rest of the year, probably not what we want in our flower garden.

54:54We want impatience. We want heliconias, annuals, semi-annuals. We want evergreens like Stable Value. We want all these things that something's in bloom any given time of the year. That's my all-weather portfolio, how we design portfolios. Is the all-weather portfolio something that is still designed and is desirous? I think so. It's maybe a little bit boring, but boring works, right? And, you know, all weather to your analogy with the garden, to us, it doesn't mean that everything works all the time. It means that something and hopefully multiple things should work all the time in the portfolio.

55:38Yeah. Right. And again, just kind of if you take the economic cycle, looking at growth, strong, weak, accelerating, decelerating inflation. Is it high? Is it low? Is it accelerating? Is it decelerating? you have a bunch of different quadrants there and you can kind of frame out across the suite of asset classes that you can allocate to having a certain amount of your assets in those in areas where they should do well at different points of that economic cycle of that of that inflation cycle. And diversifying across those gives you a much more steady and predictable return stream over time. That's the all-weather moniker.

56:25It sounds like you are a user of, let's see, I'll just give him the three letters. And if he knows, he knows, because I know you, well, we'll talk about this in a second. RRG. On Bloomberg? Yeah. Yes. RRG. I don't know if you had a hand in building that because for those who don't know, Tom spent some time, very quality time at Bloomberg back in the day before he was positioned at Franklin Templeton. But RRG is a wonderful, we've actually created, RRG and Bloomberg has a little bit of a secret sauce that they use to create, which it's called a relative rotation graph, and how they look at what is on one axis, Tom, it's what is, it's the speed of the move, right?

57:11And the other one's the, one's the velocity of the move, and one is the outperformance. Is that right? Yep. Yep. So you get this. And if you put in, let's just say, the sectors of the S &P 500, you can watch what's kind of almost, okay, like what's really performing well now, but it's losing its mojo. And then what's kind of like all of a sudden, wait a minute, what's that little guy making the move? It's like a horse race that guy's on the outside. Number seven's on the outside and he's coming in and he's taking over. And RGS, that's good stuff. If you could teach advisors, investors, one principle of portfolio construction that's maybe misunderstood, what would you say that is?

58:00Probably diversification, right? And I think a lot of folks think diversification means owning a bunch of different things. And we would tend to disagree. Um, getting back to the kind of economic outcomes and economic regimes, we think that diversification means owning things that respond differently to the same economic outcome, right? Um, stocks and high yield bonds are different securities, but they share a substantial exposure to economic growth. So, you know, if you have a whole bunch of high yield bonds, they're going to do poorly when the economy is doing poorly. very different than other types of bonds within that fixed income segment.

58:47Public equity and private equity, they have very different liquidity profiles, but they often share the same kind of fundamental economic engines behind them. Long duration treasuries and short duration credit to that point, they're both fixed income, but they can behave completely different during an economic shock. So having diversification amongst kind of exposures to various economic and market factors is really what diversification is all about. The other thing that I would say, and we hear this all the time, investors often evaluate individual positions rather than the full portfolio. Yes.

59:31And we hear this regularly. Why do we own this certain asset that hasn't performed well recently? Yeah. And sometimes the answer is that's precisely why we own it, right? So if everything is working simultaneously, there's a reasonable chance that everything is exposed to the same underlying factor, and thus you don't have proper diversification. So, you know, really, as long as all the assets are behaving as they're expected, it's perfectly fine for some portfolio assets to be falling in value at any given point in time. So maybe said another way, a good diversifier should actually occasionally disappoint clients.

1:00:11And if it never does, it's probably not diversifying enough. I had a conversation with an institutional manager who ran an equity portfolio, and it was rather, I would say, constrained. It wasn't an index base. It was an active. And he said to me that the first thing he does every day when he comes into the office, he looks at his portfolio to try to figure out which one of the stocks he had is the biggest dog now and into the future. He's always looking for that one name honestly. That's a little bit different than a client, which we have a client that I can think of right off the top of my head.

1:00:47When you mentioned this, I was thinking about it. It's like, why do we have this one position that's not doing well? I'm like, not doing well over what period of time are we talking about, right? It's not doing well over the last four days when things are doing well. But did you look at the last three weeks before that, right? Or is it the last six months that that one? But that one, there's always going to be, you're always going to have one dog in the portfolio, the least performer. But that doesn't necessarily take it out as a bad position inside the portfolio, the way I'm looking at it. So when you look at, though, but you look at, you mentioned diversification.

1:01:24I think the diversification is also looking at correlation coefficients of the various positions when we look at broad-based positioning, right? Large cap stocks or equities versus real estate and looking at the correlations of that. Lately, since the great financial crisis, I think correlations have kind of narrowed a little bit from where they were historically. It was always like, OK, stocks up, bonds down. That's not really the case anymore either, right? That doesn't necessarily happen. But theoretically, it kind of hasn't. So a lot of that stuff is gone. But how do you, when you are looking at all of this and you look at the correlations and we talked about risk, do you use, for example, when you're working this out, the correlation, you look at information ratios or you look at maybe alpha, betas when it comes to sectors, right?

1:02:19But what do you use as your risk component? Is it downside volatility, standard deviation? Because there's a lot of standards that people use. What do you guys use? Yeah. Kind of all of the above, right? You do want to have a holistic view on the portfolio. And, you know, oftentimes volatility is thought of as the definition of risk. We would say that it's a measure, you know, one of many measures of risk. and volatility kind of measures how the portfolio moves around, right? Does it move around a lot or does it move around a little? Risk in many ways for us is that the portfolio fails to do the job that it's hired to do, right?

1:03:04And so we will tie risk factors and risk metrics to the objectives that we are seeking to achieve with the client, right? So some of that can be falling short of a benchmark. Some of that could be losing money. Some of that could be not generating enough return over time. And so there's a whole slew of different metrics. Value at risk is one that kind of says in a bad case scenario, like the worst 5 % of the time, what would your portfolio potentially lose? We'll also look at conditional value at risk, which basically says in that worst 5 % of period, what is the average drawdown or loss potentially look like?

1:03:59There's a number of different things that I'll try to kind of put together when looking at how well we've done on portfolios beyond just kind of risk and return. things like hit rates. How frequently does the portfolio meet its objective? Because some people will want to see steady and predictable things. Some people will be happy with a kind of a home run, hitting home run a lot, strike out a lot kind of metric. But what's the hit rate look like? What up and down capture ratios look like? So when the market goes up, How much do you capture of the upside when the market goes down? How much of the downside do you capture?

1:04:42That's an important one, as I've seen historically. You want to look at this and you want to understand that's great. Everything looks great on paper. And the long term is right on benchmark, let's say. But two things being equal and all things being equal, when you look at this one that has a lot more upside but then also took a lot more downside. and you can get to the same place in a lot smoother orientation and capturing more of the upside, or at least not capturing as much of the downside, I should say. That's probably a better way to look at it. And the ideal, I would say, with multi-asset portfolios is obviously you want to meet the objective over time with a high hit rate, i.e.

1:05:25outperforms frequently, one that captures more of the upside than it does on the downside. So you have some positive asymmetry there. And then positive skewness in that when the strategy outperforms, it outperforms to a higher degree or to a larger extent when the strategy underperforms. So, you know, you got a nice hit rate. You've got nice asymmetry on upside and downside capture. And when you do outperform, you outperform by a higher amount than when you underperform. I mean, you can't ask for anything more than that, right? But most of these tools are not available. I mean, you can find some things out there, Morningstar and a few other places, about individual funds, individual strategies.

1:06:15Most people don't have this ability to do that with their own portfolio. Again, there are ways that you can basically take daily, weekly, monthly, quarterly, annual returns into even an Excel spreadsheet, right? And get a lot of these statistical measures if you know how to manipulate that. You probably could use the AI these days, now that I think about it, to just stick returns in. Because it's really return-based, right? Because we're looking at the overall before you break it down into the next level. Last question I have for you, my friend, is you've been doing this a while. And how is the asset allocation, portfolio construction, looking at a capital asset pricing model to create, overlaying with a little bit of dynamic, also taking consideration the portfolio requirements, client requirements, time horizon.

1:07:06How has it all changed in the last 20 years? Yeah, in some ways, a lot has changed. In some ways, not much has changed, right? So we're still trying to assemble a collection of assets that give investors the highest probability of achieving their goals. Full stop, right? And that has not changed. The tools have changed enormously over the last, you know, call it 20 years or so. You know, specifically, we've moved from asset classes towards risk factors. I've mentioned this before, right? So 20 years ago, the discussion was around stocks, bonds, and alternatives. Today, we think a lot more about growth, inflation, duration, liquidity, volatility, and other risk premia.

1:07:48And that's kind of an intellectual evolution, if you will. Um, investable universes have exploded. ETFs are much more prevalent today. Um, there's, there's a lot of private credit that, you know, over the last couple of years has become en vogue. Private equity, um, has become a lot more available, you know, to, to, to, to the, the average investor. Um, we have liquid alternative strategies now. Now, systematic strategies are kind of all the rage and we utilize them a lot. And we've kind of moved from funds to direct securities or sleeves of underlying strategies. And, you know, that that provides more tools, but it creates more opportunities to also build unnecessarily complicated portfolios.

1:08:38We have to always keep that in mind. Right. Right. Alternatives, particularly privates. I mentioned, you know, they were primarily institutional in the past. today, they're increasingly part of wealth portfolios. That's a positive, but it does create challenges around liquidity, valuation, capital calls, portfolio construction, manager dispersion, all those kinds of things. And then maybe finally, technology has really transformed the implementation of portfolios, right? Trading costs are a lot lower, portfolio transparency is improved, information travels almost instantly, but in some ways, faster information hasn't necessarily created better investors.

1:09:22And we've reduced the time required to obtain information from, you know, in some cases, days and weeks to milliseconds. I am not convinced that we've reduced the time required to make a bad decision. Yeah, that's always, there's always plenty of time for that. Always plenty of time for that. Tom Nelson, Franklin Templeton, portfolio manager, extraordinary. I appreciate you sharing all this with us and breaking this down. Like I said, I mean, not every, well, most investors don't have all the tools that we have at our disposal, that you have at your disposal to create this. And that's something that can be rectified by actually utilizing some managers if people find that desire to do so.

1:10:08But I appreciate you coming and educating us on all this and sharing all this wealth of knowledge. Always great. Thank you. Thanks. Well, we ran a little over on this show, but I think it was pretty worthwhile. And we did cover a lot of information. And I got a little animated. I got a little bit crazy. Sometimes I talk a little fast when I get into a ranting mode, into one of those moments that I get very passionate about what I talk about. And the whole Operation Twist and the issue about strategic oil reserves, ah, that got my panties in a little bit of a rumple. So maybe you have to listen to that at half speed or something like that.

1:10:48We're going to be back next week. We have some great guests coming on for the rest of this year that I booked. Thanks for joining me this and every week. I'll see you real soon. This podcast is intended for informational purposes only and does not constitute personalized investment advice. Investing involves risk, including the possible loss of principal and past performance is not indicative of future results. The views and opinions expressed are those of the host and any guests and may not necessarily reflect those of Horowitz and Company Inc., an investment advisor registered with the U.S. Securities and Exchange Commission.

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1:12:24We'll be right back.