This is a follow-up to my post from yesterday on perils of relying on an analyst’s investment recommendations.
The FINRA article I mentioned in that post comments that institutional investment decisions can be motivated by considerations that differ markedly from those we as individuals face.
What does this mean? Here are some examples:
1. for almost two decades, endowments (like those for universities) have made large investments in highly illiquid “alternative” assets. They argue that their financial circumstances allow them to take liquidity risk in search of extra-high returns because they won’t need the money for, say, 25 years.
Such investments present several problems for you and me:
generally speaking, endowments haven’t cashed out of many of these investments, so it’s not clear how well they’ve done
we probably don’t have a 20-year+ investment time frame, and
we definitely will only be able to participate in alternatives on much less favorable terms than big institutions. In retail-oriented projects, the organizers reap most of the rewards.
2. An institution may try to offset the risk of “roll-the-dice” investments by being very conservative in other areas. Without knowing its overall investment strategy, it’s hard to know how to evaluate any one part. So when an institutional portfolio manager says he has a huge weighting in Treasury securities, it may be that he’s acting on instructions from his client, or it may be to offset the risk of holding a ton of risky emerging markets debt.
3. Portfolio management is a craft skill that sometimes operates on less-than-obvious rules. The IT sector, for instance, is the largest component of the S&P 500, making up almost 20% of the index. The largest constituents are Apple, Microsoft, IBM, Google, and Intel.
Let’s say I’m a PM and I don’t like the IT sector right now. I probably won’t express my opinion by having no technology stocks. To make up a number, I may elect to have 15% of my portfolio in IT. If I’m right, I’ll make gains by having the “missing” 5% invested in a better=performing sector. I may also decide that, because I want to be defensive in this area, I’ll shift my emphasis toward the biggest, lowest-multiple, most mature companies.
But that’s the point. These will probably go down the least in a bad market.
As a result, I may end up having 3% of my portfolio in AAPL and another 3% in MSFT. They may also be the largest holdings in my portfolio. A cursory glance at my holding may give the impression that I like AAPL and MSFT. I do, but only in the sense that I expect that they’d go down–they’ll lose less than smaller IT stocks, gaining me outperformance. They’re my hedging alternative to making an all-or-nothing bet against IT.
Another situation: let’s say I have no clue how AAPL will perform. I may decide that I should concentrate my attention elsewhere in the portfolio, where (I hope) I can add value. The easiest–and safest–thing I can do with AAPL is to neutralize it. That is, I hold the market weight in the stock. Yes, I won’t gain any outperformance this way, but I won’t lose any, either. Because AAPL is the largest stock in the S&P 500, AAPL may end up being my largest position. But, again, this doesn’t mean I like it. It means I don’t want the stock to hurt me.
Will I explain any of this in an interview? Yes, I’ll try. But reporters’ eyes will glaze over. What they’ll come away with is the idea they came in with–that my largest positions must be my favorites, and they’re AAPL and MSFT.