8/14/2013

What Does Your Asset Allocation Look Like?

Investing is not only about stock picking. Investing is more about being aware of the risks and the potential returns associated with each asset class and allocate your assets accordingly.

Charlie Munger, one of the greatest minds of our time, invested most of the money in the small portfolio he manages at the DailyJournal (DJCO) in Treasury notes and bills for decades while he was talking about the Art of Stock Picking. He switched the majority of the portfolio into stocks during the market low of 2009, when stocks were positioned for the best return for the next decade.

Robert Rodriguez, a rare value investor who also has a good grasp of the macro picture, said in a recent interview that he would have 40-45% of FPA Capital Fund in cash if he were still running the fund. "In my own account, I have even more cash," he said. We must give credibility to Mr. Rodriguez for his long-term track record. He issued a "buy freeze" and held more than 40% of portfolio in cash right before the market started to crash in November 2007.

Prem Watsa, highly regarded CEO of Fairfax Financial Holdings Ltd. (FFH), wrote in March that "We continue to fully hedge our common stock portfolios as our concerns about the United States…" You would think he has been wrong with the hedging as he is losing money with them. But the last time he was losing with hedging was during the last bull market from 2004 to 2006. He then made a killing with the hedges in 2007 and 2008.

You can see that these great investors are doing quite differently. But they all manage portfolio risk by not fully investing in stocks. The outcome of a portfolio is not much about how the stocks in the portfolios perform but more about what asset classes they invest in, and how much market exposure they have during market downturns.

Although we strongly believe that over the long term, reasonably valued, high-quality stocks such as the ones in our Buffett-Munger screener will do well, and you should only invest! in high-quality stocks. Value investors should also pay close attention to total market valuations. When the overall market valuation is high, the downside risk of even holding a high-quality portfolio is high. A conservative asset allocation will make it possible for you to buy high-quality companies at even better prices.

We have no way of knowing when the market will be back to a more reasonable valuation. Holding cash and watching the market continue to march up is one of the hardest things to do in investing. But it is also one of the most important things that differentiate a good investor from a poor one.

Robert Rodriguez has more than 40% of his portfolio in cash. What about you?


Related links:Treasury notes and bills for decadesArt of Stock PickingRobert RodriguezPrem WatsaBuffett-Munger screener will do wellYou should only invest in high-quality stocksTotal market valuations

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