“Keep your eye on the ball and hit ‘em where they ain’t”
It was at an “ideas” dinner that I was introduced to Mike. Someone from the host firm grabbed me and said: “You should meet Mike, he’s doing the same thing you are”. That thing was building a track record in global bond investing as a precursor to creating a business in the asset class. What I remember from our conversation was how Mike framed the problem. Our common yardstick, the FTSE World Government Bond Index, was dominated by three markets: the US, Japan and Germany. Mike thought that getting those three markets right was the key to his performance. I listened, nodded politely, but walked away feeling that I just did not agree with his view of the problem. I preferred to seek opportunities in niche markets, misperceived situations and mispriced securities.
Consistently timing large bond markets is nearly impossible. Most market commentators have been calling for higher rates every year for the last decade. Their batting average has been a lot lower than Wee Willie’s. Willie’s lifetime average of .341 places him 14th on the all time list. Pretty good for a guy who made a living shooting the gaps, bunting and dinking balls over the infielders.
Indexing large efficient markets like the S&P 500 or the US government bond market has been an efficient way to access their returns. Paying premium prices in attempts to beat them has proven to be a waste. Investments that can add to your returns versus your strategic allocation are likely to be found in niches that do not scale, in securities that should be unaffected but fall in sympathy with those that should, or in situations where prices overcompensate for risk.
There are such niches. They are hard to find and evaluate. Worse, they are often buried in portfolios of filler. In Portfolio Management: Cooking With Hamburger Helper, I talked about the fact that equity portfolio managers typically have a handful of high conviction ideas and that those ideas have been proven to do well. The rest of their portfolios were Hamburger Helper. This holds in asset classes like global bonds too.
In the global bond world, the major markets are beta, standard exposures that can be accessed simply and cheaply. I spent my time on other things like buying unrated Iraq bonds post US invasion, because US involvement meant I was overcompensated at the price I paid. I bought Mexican T-bills during the Asia crisis; their yields had risen to 35% and I was pretty sure that Mexico wasn’t in Asia. I bought Israeli bonds and hedged them into US dollars with mispriced shekel currency forwards for a significant, yet low risk, yield boost. All of these things involved mispricing, misperception or niche markets. All were buried in my larger portfolio; they helped performance at the margin, but didn’t dominate. I had to consider overall portfolio risk. My investors did fine, but they paid my employer for a large ribeye while receiving a just a taste.
In my opinion, the way to square this circle is to maintain a strategic allocation in low cost strategies while reserving a portion of your portfolio, if you’re inclined, for strategies or individual investments that have the potential to add excess value. Some managers can provide such strategies, but don’t be fooled; they cannot offer them across a well diversified portfolio. Do not pay luxury tax for a buffet size helping of filler leavened with an amuse bouche portion of investments with the potential to add value.