6 common investment mistakes. 1. Being Too Conservative
Burned by two severe bear markets within the past decade, many investors are still gun shy. However, allocating the bulk of your portfolio to cash has never been a winning strategy over the long-term. In fact, with cash currently yielding close to zero it can negatively impact your standard of living in an inflationary environment (see our article Beware The Real Cost Of Your Cash Allocation for more on this). If you hold significant amounts of cash, consider reallocating to more productive asset classes without incurring too much additional risk.


2. Stretching for Income or Yield
Perhaps the flipside of the mistake noted above, some investors have searched too hard to find income generating assets. They are often enticed by a high yield, but don’t fully understand the credit risk, interest rate risk, or illiquidity risk they are taking to achieve the projected income on the investment.
For example, many investors were attracted to Auction Rate Preferred Securities (ARPS), but these seemingly safe securities returned in many cases mere pennies on the dollar in the midst of the credit crisis. If income is a priority, consider diversifying yield through sources such as traditional bond funds, MLPs, and emerging markets debt, among others. For example, we include SteelPath Alpha MLP (MLPAX, the first open-ended MLP mutual fund) and Lazard Emerging Income (a limited partnership focused on short-term sovereign debt) as alternative yield drivers in our client portfolios.


3. Timing the Hedge to a Portfolio
During the throes of a bear market many investors substantially increase their allocation to hedge funds or other investments that provide downside protection. By then it is often too little too late and, perhaps more importantly, investors fail to effectively benefit from an eventual rebound. In our view, investors should have downside protection as a core, ever-present part of their portfolios, while also maintaining attractive upside potential. We detailed this “permanent hedge” approach in a prior column (Rethinking Long-only Equity), noting investments such as The Gateway Fund (GATEX) and our own proprietary strategy which uses a combination of ETFs and options to control risk and enhance returns.


4. Having a Portfolio that is Too U.S. Centric
Economists have coined the term “home country bias” to illustrate that investors typically have 90% of their assets in domestic (i.e. U.S.) based investments. However, principles of diversification show that international exposure should be higher than the typical 10% allocation to account for the large percentage of world GDP contribution from overseas markets. Additionally, it is clear the bulk of the growth in this century is coming from the emerging markets. Therefore, it is logical investors should increase their overseas exposure, albeit in a risk controlled fashion. A new fund we like for this is the PIMCO EqS Emerging Market Fund (PEQWX).


5. Owning Too Many Illiquid, Leveraged and Non-Transparent Investments
The endowment model, espoused by Yale and others, sailed along during the 2000-2002 bear market that followed in the Internet bubble, but revealed its inherent weaknesses during the credit crisis, when many endowment funds fell in excess of 30% in 2008. The secret that drove much of their prior success was an overreliance on illiquid and highly leveraged investments, such as private equity funds.
Furthermore, the lack of transparency with many private investments, including hedge funds, makes it difficult for their owners to understand the fundamental drivers of investment results. Hence, many investors were caught off guard as their investments imploded in 2007-2009. In rare, but devastating cases, as with Bernard Madoff, there may be outright fraud. Investors should always favor transparency, liquidity, and lack of leverage in their investment choices. This is especially important when implementing a “permanent hedge” approach as suggested above, as many hedged solutions are inadequately liquid or transparent.


6. Not Risk-Adjusting Investment Returns
The oft repeated maxim “there is no such thing as a free lunch” has proven its sagacity over many decades. High returns are almost inextricably tied to high risks, but these risks often have not yet manifested themselves. Investors should compute risk-adjusted returns for all of their investments. Furthermore, risk should not simply be tied to historical volatility. Prospective or concurrent measures of risk, such as liquidity, leverage, drawdown potential and transparency, should also be incorporated in any thorough analysis. Inflation is also a risk factor many investors neglect to consider. Funds such as the new Loomis Sayles Multi-Asset Real Return fund (MARYX) aim to mitigate the risk of inflation on purchasing power.