In 2002, we wrote an article “Laissez Bear” that was published in Barron’s magazine. In this piece, Valentine Capital discussed investment personalities and the importance of knowing what kind of investor you have become. Over the years, we have learned that there are many types of investors. For the sake of simplicity, we will review Valentine Capital’s 5 personality types, and then discuss the allocation tool that can meet the needs of all of these investment personalities.

When we first started in this business, the lasting effects of the Great Depression dominated our client’s investment perspective. The Bob Hope Generation, which are those who grew up during the Great Depression, measures their investment performance based upon their ability to survive and maintain a comfortable lifestyle. They are uncomfortable with risky investment opportunities and would rather have consistent dividend payouts than runaway growth. Because this group of investors grew up in the 1930s and are WWII heroes, their childhood and young adult memories are of poverty, want, and war. These images have impacted their attitude towards spending, saving, and investing. They won’t spend $3.00 for a cup of coffee nor will they be purchasing an iPod. Ultimately, they view investing as a way to sustain and maintain their financially conservative lifestyle. My father (born January 1932) and uncle (born in October 1929) fall into this personality type. Their father died during the Great Depression and they were raised by a single mom who stressed hard work and self/family preservation. When my father retired and began taking a $900 monthly distribution from his account, he put aside a portion of this money “for a rainy day”, spent another portion on his 18 grandchildren, and still had money left over at the end of the month. Those of the Bob Hope Generation rarely “waste” money.

The Scientific Investor wants to see an investment formula. They try to engineer the “perfect” blend of growth and value potential. In other words, they are conservative, value minded, aren’t totally risk-averse, and may even have a small portion of the portfolio as aggressive growth. It is about precision and detailed allocations. Their mantra would be “I want to stop losses in my portfolio, even if I don’t set the world on fire.”  Valentine Capital has a share of engineers that fit this mold.

The Laissez-Faire Investor is the Baby Boomer who took pride in building up a 401(k) and then wants their hard work of building that nest egg to be used as retirement income stability and for leaving a financial legacy to their family. These individuals didn’t spend a lot of time or energy through their 30s or 40s tinkering with their investments. They were too busy working and saving. In terms of investing, the Laissez-Faire investor desires investments that yield high income, preserves principal, and keeps taxes low. Their goals are to have moderate risk, not to outlive their income, and to spend their time and money on being wonderful grandparents.  Most of our current clients are in the Laissez-Faire category. These individuals lived through the 1970s disco years, wore the polyester suit, and now are spending time emailing pictures of their grandchildren and latest family vacation to their friends.

The Beat-the-Joneses Investor is the investor that has the most unreasonable investment expectations. They watch the market closely, evaluate Wall Street's musings, are logical, but are chronic worriers and focus on investment problems, rather than promise. They consider themselves risk takers, but not gamblers. This investor might fall prey to what we call “Babe Ruth Syndrome”. They would point to and analyze Ruth’s strikeouts (1,330) while downplaying the immense number of home runs (714) he hit. Our office used to see a lot of this kind of investor. I would go as far as to say this mindset was formerly our biggest group.

The last investment personality is the High Roller. This kind of investor is knowledgeable about the markets and has an intimate understanding of risk. Risk volatility doesn’t alter the plan, instead they embrace aggressive growth. Such an individual likes to  have 100% of their money in equities. Their idea of diversification is spreading their dollars among aggressive-growth, growth, and small-cap stocks. Inherently, investors of this sort are philosophic when they suffer a loss because they have an intimate understanding of risk. Our office has very few clients that fit into this group.

After revisiting this article and really thinking about our specific clients, I tried to determine the one investment option that works for all of these personality types. Not all clients need or desire cash flow or growth or even some preservation.  Although Valentine Capital’s basic wealth management philosophy starts with generating cash flow, it is important to consider other investment types.  (See previous cash flow articles on our website). Furthermore, all clients could use alternative investment opportunities (also known as noncorrelated investment) to meet their individual investment goals.  Alternative investments allow for risk diversification. Non-correlated investment strategies can be used by investors to neutralize, or counterbalance, the risk from traditional stock and bond investments. In order to do this, investors typically place between 5% and 30% of their total investment portfolio into alternative investments to protect the remainder of the portfolio from downside risk. Minimizing downside risk is one of the fundamental characteristics of alternative investment strategies. Or, to put it another way, alternative investment managers ideally seek to generate positive returns irrespective of the direction of the market. Increasing bonds or cash flow orientated investments won't always achieve risk mitigation or positive results. Instead those outcomes are achieved by providing clients with non-correlated investment options. Ultimately, it is all about alleviating risk.

Prudent advisors must find tools to help their client’s overall portfolio.  Our mantra for the last 2 decades has been “Overweigh and Underweigh, but Don’t Eliminate."You must have a diverse portfolio and understand how each element within that portfolio affects the whole.  

Investors can diversify in many ways. For many high net worth investors, this has traditionally resulted in a portfolio blended with stocks and bonds and the occasional real estate holding.  However, during times of market stress, the performance of these assets can begin to correlate. When this happens, the benefits of diversification are lost. This is why looking outside the box is important. Diversification using alternative investments may help your portfolio respond to different types of market conditions. Including noncorrelated instruments can be a vital part of the whole portfolio’s success.

Let’s look specifically at the benefits of noncorrelated investments:

• The first benefit is the opportunity to balance a portfolio’s volatility or risk. This balancing of the portfolio is possible because of the low to slightly negative correlation between these investments and equities and bonds. One of the key tenets of Modern Portfolio Theory, as developed by the Nobel Prize economist Dr. Harry M. Markowitz, is that more efficient investment portfolios can be created by diversifying among asset categories with low to negative correlations.  Simply put, a truly diversified portfolio contains not only a range of different asset types, but also assets that have low correlations to one another. Constructing your portfolio this way will reduce the likelihood that your assets will move in tandem, which can be especially important when the broader markets may be down and diversification may be most needed. Noncorrelated investments draw their returns from different sources than traditional stock and bond investments. Consequently, they can often provide positive returns while stock and bond markets decline.
• The second benefit is the potential to enhance a portfolio. Adding an alternative investment product to a traditional portfolio improves overall diversification of all of the investments. This is substantiated by an extensive bank of academic research, beginning with the landmark study of the late Dr. John Lintner of Harvard University, in which he wrote that "the combined portfolios of stocks (or stocks and bonds) after including judicious investments in leveraged managed futures accounts (for example) show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone." Lintner's research was substantiated by a 12 year study by Managed Accounts Reports.
• The third benefit is the ability to profit in any economic environment. For example, during periods of hyperinflation, hard commodities such as gold, silver, oil, grains, and livestock investments tend to do well, as do the major world currencies. During deflationary times, futures provide an opportunity to profit by selling into a declining market with the expectation of buying, or closing out the position, at a lower price. This strategy can even be used in flat or neutral markets. Yes, this is trend following. However, it is through these types of disciplined trading models that we participate in the momentum strategies that sometimes drive market trends to extremes. The key here is a disciplined approach to exiting profitable positions when momentum changes at turning points in select markets. This type of risk management assists us in avoiding staying too long in a market trend driven by momentum investing.
• The fourth benefit is the opportunity to easily participate in global market investments. 
  Some noncorrelated investments can participate in at least 50 different markets worldwide, including stock indexes, financial instruments, agricultural and tropical products, precious and nonferrous metals, currencies, and energy products. These trading advisors thus have ample opportunity for profit potential and risk reduction among a broad array of non-correlated markets and different trading approaches.

All investment vehicles have risks and potential declines in performance. Alternative investments, of course, have periodic "drawdowns" (declines in value). However, over the long-term, they can provide consistent, attractive appreciation. These financial instruments have proven their resilience and diversification benefits to many investors. As a result, we believe that noncorrelated investments can be a critical asset for the portfolios of sophisticated and suitable investors. According to Chen, Zhu, and Armstrong, “Including Managed Futures also improves the risk-return tradeoff of the long-term asset allocation portfolio, thus benefiting long-term investors” (Ibbotson Associates, August 2006). 

At Valentine Capital, investors can choose which noncorrelated product is appropriate for their retirement objectives. Currently, our office is adding the following alternative investments to our portfolios: QIM (managed by Jaffray Woodriff), Winton Capital Management Futures Fund, Citadel Investment Group, Private REITS, Private Placements, and Brevan Howard.

It doesn’t matter if you are from the Bob Hope Generation mindset or the Beat-the-Joneses there is an alternative investment product that meets your needs. You have choices.

*Diversification may help reduce, but cannot eliminate, risk of investment losses. Historical performance relative to
risk and return points to, but does not guarantee, the same relationship for future performance. There is no assurance that by assuming more risk, you are guaranteed to achieve better results.

 *This material is for general information purposes only and should not be considered a recommendation to buy or sell any security, or of a specific investment strategy.

*Asset allocation does not guarantee a profit, nor protect against loss in a declining market.

*Please consult a financial advisor regarding your specific situation prior to implementing an investment plan.

*Past performance does not guarantee future results.