Investment Policy Statement, Part II

Yesterday I posted a proposed draft copy of an IPS (Investment Policy Statement) our legacy planners gave me. I said I didn’t feel comfortable signing the document without further input . . . from our investment advisor himself and, perhaps, one or two other similar advisors.

Today I thought I would share some of the things I wrote to our investment advisor about the document. So here’s the cover letter I sent him:

S______:

I’m attaching a document M_____ and J______ sent me yesterday afternoon.

They said they hoped Sarita and I could come to some kind of agreement about it and then share it with you to see what you might have to say. I told them I appreciated their consideration, but I really wanted–indeed, felt I needed–to get your feedback first before I could agree, much, to anything. I sense I am unable to form an opinion about the document at this time–without your (or someone else’s) input, because I am too uneducated on the subject matter.

I feel kind of stupid not being able to form opinions on my own, but the truth is, I find it very helpful to have different people–people with good education and strong opinions–who can ask questions and help me look at things from different perspectives. They said that was fine; they had absolutely no compunctions against me showing this to anyone. So I’m showing it to you. (I also intend to send it to J_____ J_____, and, actually, a third guy, someone from F______ I_______, who has been trying to get us to invest through [their firm]. Since they keep “knocking on my door,” I figure I might as well let them get a look at what “we” (or, at least, our legacy planners!) are thinking and talking about.)

I guess I’m not completely without opinions. I actually think I see two main difficulties with the document as it is written right now. And this is what I said to M_____:

1) I would really like to see some further distinctions among the different accounts we oversee: _________ LLC, InquisiCorp, __________ FLP, _________ Enterprises, etc. I sense each one needs to have distinct time horizons, asset allocation guidelines, risk tolerance statements, and so forth. [M_______ said he agreed; we need to get there. But this is intended as a first draft indicator of the kind of statements we should be looking for with respect to the individual accounts. All of the individual accounts, together, should, in some way, "total" to a statement something like the one they have written and I have attached herewith.]

2) I am very uncomfortable with the Asset Allocation Guidelines as written. I don’t know what these guidelines should look like, but, as I said to M_____ and J_____, I sensed you might have some specific ideas that you would want to see incorporated, and I am very troubled by the idea that, without input from you, I could say, “Here’s what I’m thinking.”

In terms of the Asset Allocation Guidelines, the one thing that jumped out at me immediately was the idea that, as it appears, “Small-Cap Equities” should always be a much smaller proportion of the investment portfolio than “Large-Cap Equities.”

It’s my understanding that, during recovery periods in the economic cycle, we probably want to be more heavily invested in small caps than in large.

That’s just the one thing I could detect on my own without further input.

My over-arching thought: I sense we may need to have a number of different Asset Allocation Guideline charts, each one “tuned” for different portions of the economic cycle. [Some of that opinion, I think, comes from something I think I've heard you talk about; you don't "time" the market, but you do reallocate based on some kinds of parameters you see in the marketplace. And I see that other people seem to share that opinion. For example, on our last vacation, I happened to pick up a copy of The Well-Timed Strategy by Peter Navarro, a book about "Managing the Business Cycle for Competitive Advantage" in one's own business. So if it's good for a business, why wouldn't we invest similarly in the broader marketplace as well? --As Navarro seems to indicate, there's a time for risk management; a time for capital expenditure; a time for acquisitions; a time for divestiture; etc. Shouldn't that kind of thinking be reflected in one's IPS?]

M______ said the reason they have set the Asset Allocation Guidelines as they have is because history shows that a portfolio consistently tuned to the target percentages has a 95% probability of earning between 4.7% and 12.3% per year over a 35-year period. “And this enables us to predict with some amount of assurance where your estate will be in the future . . . so we can make appropriate legacy plans.”

I said I thought you have certain proprietary algorithms that you use that give you confidence, at the same 95% level, that you can produce returns better than that.

I understand that all the micro-level decisions, together, comprise some type of proprietary methodology. But I would expect you should be able, without revealing the specifics of your proprietary methodology, to demonstrate how or why you can speak with similar confidence about the long-term performance of your methods.

Moreover, I expect you are able to make some kind of macro statement(s) that, going forward, would enable outside onlookers (like Sarita and me and/or our legacy planners, for instance) to say, “Yea, verily, S_____ is living up to the requirements of our IPS.”

But I don’t know. I don’t know what kinds of parameters you may want or need to share. Maybe the kinds of parameters they have written up will work just fine. . . . But that’s why I thought I needed your input.

I would like to note: M_____ said that he is very uncomfortable with the idea of “proprietary methods.” Kind of like your comments about market timers, so with him about proprietary methodologies: there is a deep-set prejudice against the idea that someone can really beat the system.

At the same time as he expressed his skepticism, however, he also made clear that, from his perspective, it is our decision what we want to do with our money and with whom we may want to work. “Whatever you want to do, John. It’s up to you.”

I said, “Okay.”

I said I’m not too concerned about you having proprietary methodologies. And I have no interest in trying to get you to reveal any such methodologies, but I agreed with M______’s concern that we have some kind of written IPS that will enable us to evaluate whether you (or any other investment advisors) are operating within the bounds or outside the bounds of that statement. (The old Reagan doctrine of “trust but verify.”)

Does this make sense?

Thanks so much!

John Holzmann

PS: None of us–not me, not M_____, not J_____–has yet received a copy of the policy statement you said you sent last Friday. You said yesterday that you would re-send it today.

Whatever you send, it is my sense that M_____ and J_____ would like to see something along the lines of what I am attaching herewith.

Again, thanks.

I sent similar letters to the two other advisors I mentioned. J_____ J_____ has set up a phone appointment with me by which we may be able to talk through the document.

B_____ S_____, from F_____ I______, ~~hasn’t gotten~~ just got back with me, and we should be talking tomorrow.

But I think it might be worth mentioning that I am well aware that, if we were to adopt an investment policy statement like the one drafted, it could very well preclude his firm from doing business with us. His company’s investment strategy, when markets turn as cold as they have been the last several months, includes the removal of all funds from active investment. I.e., his firm will put them in a money market. –That is definitely not a strategy that our legacy planning advisors advocate . . . nor that would be permitted by the IPS they have drafted.

Oh.

I realize I should probably mention one more issue I raised with the legacy planners themselves.

If you look at the Asset Allocation Guidelines, you will see “Invested Subtotal,” “Cash, CD’s & Equivalents,” and “Preservation Subtotal.”

“Preservation Subtotal” is “Cash, CD’s & Equivalents.” The numbers are the same.

Those numbers are huge: Virtually identical to the entire “Invested Subtotal”–and the advisors seem comfortable with those numbers. But you throw the “Preservation Subtotal” on top of the “Fixed Income” numbers of the “Invested Subtotal,” and we are talking about a portfolio that is being extremely heavy-weighted toward cash!

Beyond that, the “Real Estate” number in the “Invested” section refers solely to investments in companies that invest in real estate. But we own real estate worth at least 75% as much as the Invested and Preservation subtotals together.

I said to our legacy planning advisors: “I know a lot of people make almost all their wealth from real estate. In other words, itself is a strong form of investment. –So why aren’t we counting in this overarching Investment Policy Statement?”

They said, “We will get to that. But we are primarily concerned about securities and bonds right now.”

Anyway.

I thought you should hear what’s going on.

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