What can the “Great Train Robbery” teach us about investing? The Great Train Robbery in this instance refers to the common description of the trade for Herschel Walker by the Minnesota Vikings/Dallas Cowboys in 1989. In an era before running backs were known for receiving and all-purpose yards, Herschel put up 4,859 receiving yards and 8,225 running yards. He was an All-Pro, All-Purpose running back on a bad football team (Dallas was 3-13 in 1988 and 1-15 in 1989). Minnesota, on the other hand, was a good team who felt they were missing one thing… a hall of fame level running back. So Minnesota traded away five players and eight draft picks, which the Cowboys then turned into the foundation for three Super Bowl victories in the 90’s. Sadly Minnesota and Herschel never won a Super Bowl and he was gone from the team in three seasons.
Even more sad and more relevant is how some investors invest like the Minnesota Vikings circa 1989, sacrificing the team (or portfolio in this analog) for one shiny object. They place all their bets (or at least an oversized bet) on one item. History is riddled with investors who went all in on Cisco in 1999, real estate in 2007, Nifty Fifty stocks in the 1950’s, and Japan in the 1980’s, etc… Currently, you could argue there are similar analogs. Does Nvidia follow a pattern akin to Cisco in 1999? In 1999, no one knew exactly how the internet was going to change the world, but they knew they needed the infrastructure (aka, the “picks and shovels”) to get ready for it. In addition, you had Y2K pulling forward purchases for a yet to be determined future. Would the internet change things? Certainly! Will artificial intelligence change things? Certainly! However, is it also possible that we have pulled forward the dream of AI, and by extension, the price of Nvidia to a level that will not make it a beneficial trade five to ten years from now? Keep in mind it took Cisco roughly nineteen years to return to its peak price level from March of 2000. In the meantime, they more than doubled their revenues showing that sometimes a good company isn’t a good investment if you pay an inflated price for them. On a more topical level, Cisco didn’t make investors’ portfolios any more dynamic (or better, in our minds) as its success was tied to the economy and its price level. We believe client portfolios are like a team with multiple players serving important purposes. You need offense and defense, not 11 quarterbacks and zero defense, or eleven cyclical, semiconductor stocks with zero defensive stocks.
Another analog to an uneven football trade, in our opinion, is private equity. For years, private equity has crowed about how their returns are similar to the S&P 500 with half the volatility. Yet many of them own illiquid real estate, venture capital, start-up companies or mezzanine companies that banks will not finance any more. Somehow these sectors go down in the public market because their price is marked to the market, but in the private market, they don’t fluctuate because their auditors say they don’t. Our skeptical nature makes us struggle with the inherent conflicts of interest in this model and the fact that gravity doesn’t seem to apply to these assets if you put them under an illiquid umbrella. We noted that the CIO of the Retirement System in Idaho famously referred to the “smoothing” effect of returns in PE as “phony happiness” in our 2018 Asset Management Letter. We can’t help but think of the Gordon Sumner lyric “It’s a big enough umbrella, but it is always me that ends up getting wet” [1]. We don’t want our clients to get stuck out in the rain when the “volatility laundering” as Clifford Assness of AQR Funds called it, ends for private equity. A final drip, drip on our noggin for us is that Tony Robbins of self-help/motivational speech fame just published a book called “The Holy Grail of Investing” touting private equity. Admittedly, Tony is a very successful individual, but we can’t help but fear a trade that ties all of its fortune to one thing. To be clear, we are not saying that private equity can’t work for investors in the right scenario where one realizes that the volatility number may be suspect, and the liquidity is at the fund’s discretion. In fact, past returns for private equity have been very good. However, two of the biggest private REIT (Real Estate Investment Trust) providers (Blackstone REIT and Starwood REIT) have had negative articles written about them in the Wall Street Journal and Business Insider recently referencing gated redemptions and liquidity concerns. Again, because of the nature of their business they may be fine but, in our opinion, this is not a risk we want to take for the majority of our clients at this time.
Furthermore, why would we put all of our bets on offensive assets? Portfolio construction, in our opinion, needs to be stable to compound returns over time. If all of your assets are invested in offensive assets, then you are not truly diversified. You could own private equity in real estate/technology/biotech/venture capital and then own the S&P 500 and technology stocks and think you are diversified. Every single one of those assets is offensive in that scenario, but one of those groups has your money tied up in an illiquid, low transparency, and high expense offering. Fixed income, commodities, cash, and hedges are defensive assets, but even those have periods such as fixed income during inflationary periods or commodities in recessions when they are not necessarily defensive. Thus, a standard 60% equity and 40% fixed income portfolio may not protect you well enough. In particular, periods of inflation, recession, and stagflation need assets besides just stocks and long bonds. The past thirty years have been good for this model, but the next thirty may not. We are intellectually humble enough to say that we don’t know for certain. What we do know is that studies have shown a diverse portfolio of defensive and offensive assets provide smoother returns (real mark-to-market returns at that) which allow client portfolios to compound at higher rates of return. As a simple example, if you had two portfolios with a million dollars with the same average rate of return but one was down 50% the first year and then up 100% the next year the compound rate would be higher for the portfolio that earned 25% every year even though the average annual return was the same. Both have an average return of 25% but the first portfolio has a compounded rate of return of 0% whereas the second portfolio has a compounded rate of return of 25%. One is worth a million dollars after two years and the other is worth 1,562,500 but as you can see volatility impacts your ending point more than many people realize. Hence, the need for assets that move differently in different economic regimes.
To that end and to recap, we have been adding defensive assets to client portfolios for a while now. Before long-dated fixed income demonstrated its increased correlation to the stock market with a negative return in 2022, we had already reduced our exposure to long-dated fixed income. In addition, at the same time we had begun adding to cash, hedged assets and commodities in order to protect more against an inflationary/stagflationary economy which helped our returns, but then also gave us the ability to put money to work while others were gun-shy. One of the unheralded aspects of defensive assets, in our opinion, is the flexibility they allow investors to exhibit while others are frozen with fear and paralysis as they grapple with the size of their loss in their higher correlated offensive assets. Hindsight, after a decade plus bull market allows some to forget the anxiety of 2023 regional banking crisis, 2022 inflation fears, 2020 Covid fears, Ukrainian invasion, European debt crisis and 2010 Flash Crash to name a few. Behaviorally, many investors reacted differently than the returns show over the past decade-plus. Thus, we think our adds to defensive assets were warranted and will continue to remain warranted as one can only compound returns if one stays invested. Our goal is to continue building a stable and dynamic portfolio for you that will work together to reduce volatility while still providing an appropriate return.
We hope the discussion herein shows how we consider and evaluate a broad spectrum of assets and structures as we endeavor to construct a stable portfolio for our clients. We are big fans of well-rounded teams. In fact, if we keep with our football metaphor of needing a good offense and defense to complete a winning team, you may note that the only team Herschel Walker won a championship with was the 1980 National Champion Georgia Bulldogs. While Herschel was an incredible performer on that team the defense was just as stellar. The most points they gave up in a game was 21 points. That same defense had three players on the all-time defense roster, per the UGA Wire: Scott Woerner, Freddie Gilbert and Terry Hoage. They also had one of the greatest walk-ons in UGA history, the “Tifton Termite”, Nate Taylor, who led the team in tackles even though he was too slow and too small to play linebacker at the collegiate level according to the experts. Thus, one might say the UGA team lesson might have been a better one for Minnesota to follow in 1989. Interestingly, the former college coach Jimmy Johnson is the one who pushed the Cowboys to make the trade with Minnesota. Maybe Jimmy learned something in college and maybe there is some value to a coach, analogous to a financial planner, who can put all the diverse pieces together. Please reach out if you need anything from your financial planning team.
[1] Gordon Sumner is also known as Sting from the rock group, The Police.
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