individual investor’s overall approach to management of their portfolio: goals,
asset mix, stock selection, and investment strategy. As our investment policy
guru Charles Ellis describes it:
Investment policy, wisely formulated by realistic and well-informed clients
with a long-term perspective and clearly defined objectives, is the foundation
upon which portfolios should be constructed and managed over time
and through market cycles.
The central point of investment policy is that different investors are in very different
situations and have very different objectives. So whether acting for themselves
or employing an agent, they should carefully think through the implications
of their situation and objectives for the way their portfolio is to be managed. And
once they have formulated the appropriate investment policy, taking account of
what potential achievements are realistic, they should stick with it.
Investment Policy Guru: Charles Ellis
Charles Ellis is one of the world’s most prodigious workers. He never stops. His
attaché case is always with him. And he writes. And he writes. And he writes.
Ellis has written more than a dozen investment books, sends countless
notes daily to people exhorting them to do something, and runs an investment
consulting firm he founded. On the last point, he is at pains to remind friends
and colleagues that he does not run this firm and never has. It has such great people:
It does not need running. But he is the role model at least and more than
that involves himself in everything.
The idea of Greenwich Associates was to survey users of financial services
to find out what they wanted, what they thought of what they were getting and
from whom, and to distill the data into information that could be prescriptive
for vendors of services. Not very unusual although there were important differences
from the norm. Senior people did the interviews, which were highly structured,
and the emphasis was not on the data but on the action plans that
followed. And Ellis never let any one of his clients forget that action was the important
part. His notes goaded people to move.
Ellis’s intensity is a way of life. He writes about the parallel between defensive
tennis as a winning strategy to winning portfolios. But his tennis is anything
but defensive. It is hard, determined, and “exploitative of the opponent”
tennis. And it wins not by flash but by never letting up for one minute. He never
displays a weakness that the opponent could charge.
He is the model of the goal-oriented person. His short book on investment
policy (1992) proclaims boldly that here is all you need to know in about ninety
pages. And then he proceeds to demonstrate that he is correct: It is all you need
to know. He sets targets for each day, each month, each year, and pulls himself
up to it or beyond. If he overshoots, it is because, in his opinion, he was not
tough enough on himself at the beginning.
Dean LeBaron says:
I can call Charley one of a tiny group of my most treasured friends. We have
worked together (I was one of his clients for a long time), vacationed together
on river rafts and other challenging pursuits, helped students, served
as fund directors, and shared mutual inspirational times when we both
started companies about the same time. He never ever flagged.
Ellis’s classic book Investment Policy, first issued in 1985, sums up certain fundamental
truths for institutional investors. His central point is that investment
has become a loser’s game rather like amateur tennis, where you win by putting
the ball into the net less often than your opponent. So simply by avoiding mis-
takes, you will come out ahead. His basic advice: Make a long-term commitment
to equities and stay invested.
In 1998, Ellis repackaged his book for the individual investor as Winning
the Loser’s Game, which debunks any idea of investment wizardry among the professionals.
He is especially hard on market timing, the idea that you can hope to
buy the market when it is cheap and sell near the top later on. While this sounds
simple, it does not work: markets move too fast, and even stock selection is very
hard. The key to long-term success is understanding investment risks: general
market risk and specific stock risk. Indexing carries only market risk while trying
to beat the market carries extra risks (see “Active Portfolio Management” and
“Indexing”).
Ellis writes:
The best way to achieve long-term success is not in stock picking and not in
market timing, and not even in changing portfolio strategy. Sure, these approaches
all have their current heroes and war stories, but few hero investors
last for long and not all war stories are entirely true. The great pathway to
long-term success comes via sound, sustained investment policy: setting the
right asset mix and holding onto it.
There are three levels of decision for the investor to make, and whereas
most investors take investment services as a blended package, services can be
unbundled into three separate components or levels:
• Level One—the optimal proportion of equities as the “policy normal” for
the investor’s portfolio.
• Level Two—equity mix, policy normal proportions in various types of
stocks (growth versus value, large capitalization versus small capitalization,
domestic versus international).
• Level Three—active versus passive management.
Investment counseling on asset mix and on equity mix is inexpensive and
needed only once every few years. (An individual investor with $1 million
can buy this service from an expert for less than $5,000 once every five or
ten years. An institution with $10 billion might pay $250,000.) Active management
can cost—for the management and the transactions—about 1% of
the $1 million investor’s assets.
The irony is that the most value-adding service available to investors—
that is, investment counseling—although demonstrably valuable and cheap,
is in very little demand. Active management, though usually not successful
at adding value, comes at a high cost.
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