Remember the old Abbott and Costello radio skit “Who’s On First?” It entailed a “conversation” about a baseball team with a lineup populated entirely by ballplayers whose “names” presented ambiguous answers as to who was playing what position: “Who’s on first, What’s on second, I Don’t Know is on third...”

Today’s economic fundamentals, in combination with the global flood of quantitative easing, portend an imminent inflection point in the investment cycle. Yet, the dialogue between advisors and their clients is as ambiguous as that of Abbott and Costello. While history can serve as a guide, each time is different. The facts, circumstances and global political influences are never exactly the same. Nevertheless, for the attentive, there are guideposts along the way. While it comes as no surprise that correlation among assets has increased, “The severity of how much correlation changes, even over longer periods of time, has not been adequately understood.”¹ The notion that stocks and bonds can remain “uncorrelated”—particularly when such “protection” is most in demand—is, at best, an unrealistic expectation.²

Alexander Ineichen, a well-regarded hedge fund industry analyst, notes that the key to successful long-term wealth accumulation is minimizing the investment’s “time under water”³ or “drawdown.” The objective is to maximize compounding of positive returns while minimizing the damage of the inevitable “downturn.”

The long-term success of Yale’s David Swenson has popularized the “Endowment Model” of investing. Of late, this diversified allocation, which eschews fixed income in favor of greater allocations to hedge funds and other “alternatives,” has generated more modest returns and has roundly come under fire. It is precisely these periods of uniform price movement between stocks and bonds that the “endowment model,” with its deliberate underweight to fixed income, is specifically intended to address.

The original concept was to treat the entire portfolio as a single pool of assets, and seek to generate total return in excess of the pay-out rate. Freed from a dependence on bonds as income source or volatility “dampener,” investors have the flexibility to seek assets with higher expected returns and beneficial attributes, such as hedge funds, real assets, private equity and the like. These strategies intend to capitalize on market dislocations or inefficiencies. They target specific, unambiguous opportunities, often based on rigorous fundamental research, so that the manager has a distinct competitive advantage…not some ephemeral “hedge fund beta.”

If you are a client, then, wondering “Who’s on first?”, be sure your advisor is sourcing strategies that target the inefficiencies inherent in the markets, incorporating active risk management to provide shorter and shallower periods “under water.” In this way, he or she will protect your capital in an intelligent, mindful manner…after all, this manager’s money is likely invested right alongside yours.

¹“The Volatility of Correlation: Important Implications for the Asset Allocation Decision,” Coaker, William J. II, CFP, CIMA, Journal of Financial Planning (September 2007); ²Ibid, page 5; ³“Diversification? What Diversification?” Alexander Ineichen, Ineichen Research (June 2012).