Investment Portfolios that Endure through Crisis & Cycles (w/ Danielle DiMartino-Booth & Chris Cole)
DANIELLE DIMARTINO-BOOTH: So I'm curious about your thoughts on portfolio construction, how it's done, and how it that evolution has changed basically the way this entire generation approaches investing. CHRISTOPHER COLE: Well, beginning with that and looking at what Munger has said, as a follow-up to my last letter, the Ouroboros letter that talked about the cycle of risk and how volatility has been used as both a proxy for risk and also as a source of return. I thought, how can I-- what will disrupt that-- what will disrupt that cycle? I posed a question to myself saying, well, if we're going to see what happens in the future, we have to look to the past, and the distant past, not just the recent past, not the last 10 years, not the last 40 years. We need to look back 100, 200 years to understand the cycle of capital creation and destruction. And I posed this question to myself. I said, imagine that someone gives you generational wealth, enough money that you can live and your children's children can live at a high level. But it's subject to one question, one dynamic. You have to choose an asset allocation and stick with that allocation over 100 years. What allocation do you choose so that your children's children will have prosperity? And taking that cue, I went back and looked at 90 years of historical data, backtested a wide range of popular financial engineering strategies, everything from risk parity, the traditional pension portfolio, short volatility, long volatility strategies, commodity trending strategies, and looked and how do these perform? And what asset allocation is the allocation that's going to provide wealth, not only consistently over 90 years, but through every generational cycle, through both periods of secular growth and secular decline? And what I found surprised me, that echoing Munger's statement, the allocation that the majority of US pension systems and retirees are following, which approximately today is about 70% equity-linked products- - that could be everything from stocks to private equity, things that are the profit from secular growth-- and about 20% bonds. That portfolio has done incredibly well over the last 40 years. But when you look at that portfolio over 90 years, you see a very, very different reality. And that has a wide range of social, economic, and social ramifications that become quite startling. But looking at that, I say, what asset allocation can I find that will actually provide protection over that 90 years consistently? And that answer came not from a macro view. It doesn't come from me having an opinion about whether or not we're going to go into a recession or whether or not there's going to be some continued economic prosperity. It comes simply by looking at data, using mathematics, looking at data, and looking at empirical data over a lifetime to come to that determination. And I think the results are quite shocking. And I think they run somewhat counter to the consensus knowledge as to what optimal portfolio allocation should be. DANIELLE DIMARTINO BOOTH: So Charlie Munger was right.