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Foundation Investment Advisors and Consultants
 

Insights and Publications

Colonial Consulting provides insights and analysis on current conditions and challenges, market environment, and industry trends.

Quarterly Commentaries

  • Over the last five years (yes, the Financial Crisis and its after-effects have been around that long), we have often thought of the degree to which established wisdom has been cast aside. On one hand, time passed and the crisis itself serve a useful purpose in terms of expediting the process of evolving thought and understanding. At the same time, the raw emotion of such periods can lead investors to adopt misguided ideas and abandon ideas that are good, even great.

    Asset allocation strategy is a perfect example of an area where many well-tested ideas remain relevant, although more sophisticated risk assessment is a meaningful step forward.

    Critically, many institutions have taken a major step forward in terms of considering risk from a variety of perspectives. Regardless of how we choose to view a portfolio, it鈥檚 valuable to answer the questions of 鈥渨hy鈥 and 鈥渉ow.鈥 Why are we looking at particular exposures or risks? How will we put this information to use?

  • The world changed in 2008 鈥 gone were the days of optimism, the assumption that rewards would ultimately accrue for intelligently assumed risk, and the view that those with a long time horizon need not be overly concerned with market volatility or short term results.

    Instead, we now live in a world of black swans, risk budgeting, and the pursuit of evergrowing emphasis on diversification strategies. The new order is more technical, complex and quantitative, thereby leading a small but growing number of institutions to decide that their volunteer investment committees are not up to the task of generating acceptable returns in a period where markets cannot be relied upon to do the heavy lifting that was taken for granted in happier days.

    If capital market returns are indeed on a path to continuing mediocrity or worse, this is certainly bad news for the future buying power of charitable capital and the ability of pension plans and personal savings to fund the retired lives they exist to serve. Yet we cannot help but wonder how our instinctive desire to fight the last battle and temper our worst fears through the comfort of crowds makes this more or less likely to actually be the case.

    Regardless, the news is not all bad. This is especially true for those who stand ready to stop our volatility induced nightmares through hedging, diversification and brilliant macro driven positioning. With a near daily dose of depressing news emanating from Europe, anemic global growth, disconcerting U.S. budget deficits and a host of other problems, even the most stalwart among us must wonder if it would not be wise to pursue the more crowded road.

    Based in large part on our naturally contrarian tendencies, we are not convinced and simply ask the following.

    • What is the cost of protecting ourselves from markets and their volatility in an era where the laws of supply and demand tilt heavily towards those providing a better night鈥檚 sleep?
    • Is the ascension of volatility to the pinnacle of risk appropriate?



  • With the release of Berkshire Hathaway鈥檚 2011 annual report, Warren Buffet took aim at those who have elected to utilize gold within their investment strategy. He wrote:

    鈥淭he second major category of investments involves assets that will never produce anything, but that are purchased in the buyer鈥檚 hope that someone else 鈥 who also knows that the assets will be forever unproductive 鈥 will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

    This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce 鈥 it will remain lifeless forever 鈥 but rather by the belief that others will desire it even more avidly in the future.

    The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.鈥

    Defenders point out that Buffett is not considering the ability of gold to diversify a portfolio in various economic or market scenarios and that those who hold modest allocations do so for this reason rather than from 鈥渇ear of almost all other assets.鈥 We see this as a valid argument although the debate itself raises interesting issues regarding the cost of buying insurance for a portfolio. Measuring this for gold is arguably quite difficult as would be the case when attempting to establish fair value for any asset without the potential to generate positive cash flow. As such, projecting returns is subject to even greater uncertainty than is generally the case and we can never have a good idea of what it will ultimately cost to hold gold.

    Nevertheless, in what is widely acknowledged as a deeply uncertain time, it stands to reason that the cost of most forms of insurance is quite expensive today. As highly rated government bonds are a form of insurance against deflationary environments and/or significant equity market declines, we have a perfect example of this principle at work.

  • In an uncertain and deeply troubling era, we take great comfort in the fact that time, with great consistency, marches on. While somewhat artificial, December 31 tends to carry outsized significance as we bid farewell or good riddance to the year just passed. With the misery of 2008 in mind, 2011 will be remembered as a difficult but not disastrous year and one where the pervasive nature of the financial crisis became universally apparent.

    Naturally, this revelation, accompanied by exceptional market volatility, has driven investors to consider their portfolios within the confines of the world we have now been living in for nearly five years. Yet, we continue to believe that the seemingly endless nature of our current problems and the resultant pessimism has created opportunities for those who can look past the perceived certainties of today. This view is both the product of a natural proclivity towards contrarian thinking along with an underlying sense of optimism regarding the very long-term prospects for the world at large.

    We must also acknowledge that the stress of the last few years and the prospect of more difficult days ahead is quite disturbing. Worse still,more than a decade of anemic returns from most high risk assets has created a more serious problem as many endowments have failed, over this period, to generate the returns necessary to preserve their purchasing power1.

    Failure is a powerful word as it implies that which is both final and irreversible. Fortunately, a perpetual time horizon, while daunting in terms of the amount of return that must be earned, is also useful in that neither success nor failure necessarily reflect a permanent condition. As such, the term failure is inappropriate in most cases. Nevertheless, even interim shortfalls are undesirable and we must ask ourselves what they say about the ways in which charitable capital has been invested and about how those who serve as fiduciaries will be perceived...