We would like to share with you our secret formula for delivering superior investment advice. Few other investment advisory firms share it, and most clients overlook its importance. This secret formula allows us to recommend better managers, avoid the common mistakes we see our peers making, and deliver client portfolios that regularly outperform their benchmarks and peers.
That secret is our defined Investment Philosophy.
All right, it’s not so secret. We developed our Investment Philosophy on our first day in business and it’s been publicly posted to our website ever since. While its content is not secret, though, what may be less obvious is why we have chosen to construct, document, and publish our Investment Philosophy. If that’s such a good idea, why doesn’t everyone do it? Why do so few investment advisory firms document their investment philosophy? And of those who do, why do so few of them publish it for the world to see?
Before revealing the mystery’s answer, however, let us explain why we believe that operating under a defined investment philosophy is so critical to our practice of delivering superior investment advice.
The Importance of a Defined Investment Philosophy
“Through discipline comes freedom.” -- Aristotle
First and most obviously, a defined philosophy imposes investment discipline on us. We have chosen to align our investment process with the principles that our experience and the accumulated body of academic research have proven to work. We know, for example, that a long-term focus is a sustainable advantage in investing. Having this principle documented allows us to organize our entire investment practice, from our capital market assumptions to our manager research principles, around a unified focus. It means that our research is internally consistent, and therefore positioned to inform better portfolios.
Furthermore, a defined investment philosophy brings consistency of advice to clients, and it ensures that our clients know what to expect from us. In investing, this is not a trivial concept: we know that every strategy will be tested, and even the best long-term portfolio can make the client and consultant look dumb — or worse — for uncomfortably long intervals of time. As we have written separately, the best investment strategy that a client abandons at the wrong time is inferior to an average investment strategy that the client holds for the long term. Clients need to understand their portfolios, and they can better understand them if those portfolios are developed under a consistent philosophy.
The best investment advice comes through long-term relationships between the advisor and the client, and these long-term relationships are only possible through consistency of thinking and recommendations. Clients are diverse, and organizations change over time. We believe, philosophically, that our primary objective is to craft customized portfolios for our clients that meet their individual objectives and constraints. In contrast to an off the shelf, model portfolio, a bespoke portfolio that is designed by an experienced advisor in a long-term relationship with the client gives that client the highest probability for investment success. But this approach carries risks – risks that the client’s Committee can change, that the person providing their advice changes, or that the advisory firm changes.
A defined investment philosophy guards against these risks. Operating under a defined philosophy means that whatever happens, our advice remains consistent. It guards against the temptation of chasing fads or listening to everyone’s inner market-timer voice. It leaves no room for excuses.
“If you don’t stand for something, you will fall for anything.” – Peter Marshall
We expect investment managers to show the same philosophical discipline we do. Our primary manager research database includes more than 19,000 distinct investment products on offer – about four times as many investment products as there are publicly traded stocks in the United States. In our paper Common-Sense Investment Manager Research, we documented a few of the traits that we prefer to see in active managers that we include in client portfolios. One of them is the manager’s clear understanding, and lucid explanation, of their own investment philosophy. We know that clients are best positioned for long-term success when they can invest with managers for the long term. This long-term focus confers a certain competitive advantage, but we can only have confidence that the great managers we recommend will remain great if they have a solid, grounded, stable world view. To invest with a manager that lacks one would be to set our clients up for failure in manager selection.
Operating under a shared set of research principles also serves as a filtering mechanism against the onslaught of strategies that managers are pitching to us every day. If our consultants and researchers can agree that market valuations matter, for example, we can choose to spend our research time on those strategies managed by people who understand and agree that they do. Investment managers who aren’t responsive to changing valuations may be excellent managers in their own right, but even the mere misalignment of philosophies introduces its own set of risks that our clients are not paid to take.
Which brings us back to our mystery: why don’t more investment advisory firms document and publish their investment philosophies? We believe the short answer is that they don’t have investment philosophies, and they don’t want to have them. Firms that have been around long enough to have amassed hundreds of clients and turned over dozens of consultants or advisors have likely told those clients just about everything:
“Low fees are a proven driver of outperformance.” “The level of fees doesn’t matter as long as the manager outperforms the fees.” “Focus on the long term.” “Back in 2008 we advised clients to change their allocations in response to the market.” “Markets are efficient.” “Small-cap managers tend to outperform their benchmarks.” Consultant A, to Client B: “This manager is an outperformer experiencing a rough patch.” Consultant C, to Client D: “You should fire this manager.”
For these firms, it would be impossible to adopt a defined investment philosophy that takes a stand on these issues without alienating many of their clients. They choose, instead, to continue to operate without a philosophy, hoping for the best. They have accumulated advisory baggage.
We prefer carry-on luggage, in the form of a simple, concise statement of what we agree that we know. Avoiding the potential for advisory baggage is why we adopted our Investment Philosophy on our first day in business, before our first client hired us. It would have been tempting to leave ourselves wiggle room on the hundreds of complex topics and questions that arise in the management of each client portfolio, but it wouldn’t be right. A stable and documented philosophy forces us to do the harder job of leading our clients rather than following them. It means that we can’t always tell our clients what they want to hear – but it also means that every client will hear what we really believe.
Moreover, we believe that transparency improves our investment process. While we could have chosen to document an investment philosophy and keep it private, we chose instead to publish it publically. Having our Philosophy (and our capital market assumptions, and all of our topical research) available for the world to see exposes our thinking to the rigors of public scrutiny. We are proud to sit in an academic tradition of peer review, and we believe that the investment questions our clients face are substantial enough to warrant a process no less serious. A statement of philosophy should not be “proprietary,” its inner workings secret. Only germs are killed by exposure to sunlight.
Publishing our Investment Philosophy on our first day does not mean that we stopped thinking about it after that first day; our thinking is always evolving. But the principles that underlie good investment advice and sound portfolios are relatively stable, and so too should be our interpretation of them. We set an appropriately high bar for altering our Investment Philosophy.
Solving the Mystery
It’s not a secret that the best advice is consistent and based on research, not opinions. If we were building an investment advisory firm from scratch, we would actively debate and settle our investment opinions, based on research and our experience, then document them, and only then advise our clients based on them — which is exactly what we have done. Our defined Investment Philosophy imposes rigor, discipline, and consistency to our advisory process, to the benefit of our clients’ portfolios.
Our defined Investment Philosophy is our “secret” formula only because it is so rare in our industry. The best explanation we can find for why most of our peers have not adopted one is that the weight of advisory baggage has become too cumbersome. To those firms, the idea of stable, consistent advice under the framework of a defined investment philosophy is too complicated to execute. That the simplest notion can be too complicated is the true mystery.