What's Your Core Investment Style?

Whether they know it or not, all investors experiencing the bear are faced with the age-old question of what to do with their long-term holdings in a bear market. The typical decision to make is “Do I sell it all or do I ride it out?” Unfortunately, most individual investors don't consider a third alternative, one that most professional investors decide all the time: "How much, and when, do I increase or decrease the proportion of what I own relative to the market’s mix?"

The portfolio management difference between the above can be summed up as follows:
 

• Long-term buy and hold
• Aggressively managed (pure market timing – 100% in or out)
• Actively managed (modified market timing – expanding and contracting based on economic sector weightings)

From my 30 years of experience in the investment business, the first two are what most individual investors do. The third is what many (but not all) professional investors do.

Without going into a lengthy dissertation regarding core investment principles, such as asset allocation and regression to the mean, and without delving into factors related to an investor’s risk profile and time horizon, the best way to understand the difference between how most individual investors versus most professional investors manage their portfolio is by example.

Let’s say an investor is a long-term bull on Energy stocks. Now, let’s say that this investor was prescient enough a couple of months ago to be concerned that oil prices could not be sustained at $140 a barrel. Our perceptive investor then believed that Energy stocks (XLE, for example) could be headed for a substantial enough decline that riding it out was less than a productive use of his/her assets. What to do?


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For some (the pure market timers), getting out of the entire position is the way to go. For professional investors (modified market timers), however, the choice is to reduce their exposure in XLE to below market weight. In other words, underweight Energy.

If Energy’s market weight was 15% (of the overall S&P 500), then a portfolio reduction to below that number is the course that will be pursued. Would our investor lose money when XLE declined? Yes. But would they lose less by being underweight XLE? Yes, again.

Investment Strategy Lessons Learned

This basic portfolio management principle – modified market timing, a.k.a. sector tilting – is underappreciated, underutilized, and generally misunderstood by most individual investors. If executed properly, however, the benefits of modified market timing to a portfolio’s performance over the longer-term can be substantial.

From my perspective, when deciding why and when to over-, even-, or underweight a position, the timing tools used are a blend of fundamental and technical analysis, with the fundamental being the real economy factors at work (in the case of XLE, oil’s unsustainably high price at $140) and the technical being the timing portion of the equation (such as momentum and MACD).

There’s more to this methodology, but, for most individual investors, understanding your core investment style (buy and hold, market timing, or modified market timing a.k.a. sector tilting) is a big step in the right direction of managing your portfolio.