Real Asset Allocation

"The market tends to be priced in a way that if you want to try to outperform, you have to take the risk of looking like an idiot," according to Ben Inker, the head of asset allocation at Boston-based global money manager Grantham, Mayo, van Otterloo & Co. (GMO has approximately $107 billion under management). And looking like an idiot can get you fired in the money management business, which means the markets are not efficient, since money manager behavior is predictable. Career risk is real and money managers do make decisions to avoid taking on career risk. It is far better to lose money together than make money alone. Likewise, it is important to stay up with the Jones when the market is rising. Falling behind the pack in a bull market can get you fired as well. Mutual funds are currently fully invested, with cash levels back to the 2007 lows. Its a curious decision mutual fund managers have made to go "all in" right now given the demonstrably overvalued market and the obvious catalysts for a correction/bear market, unless you understand that it is career risk that is driving the train, not investment risk. Inker's quote bears repeating because it is the alpha and omega of money manager behavior. "The market tends to be priced in a way that if you want to try to outperform, you have to take a risk of looking like and idiot." Inker goes on to explain that to outperform you have to deviate from your benchmark, and that increases the risk of under performance and, in the extreme, looking like and idiot and getting fired. It is no coincidence that fully 75% of the so-called actively managed funds are actually closet indexers according to academics (closet indexers claim to actively manage their funds but actually mimic their benchmark, leaving investors to pay high fees for something they could get for a fraction of the cost by simply investing in index funds). And what is the impact on the market as a result of the career-risk factor? Markets exhibit herd-like behavior, which leads to momentum, and money flowing into whatever strategy is doing best, according to Inker. Valuations rise to extremes within the better performing asset classes and sectors until the gravitational pull of replacement cost exerts itself. Replacement cost (Tobin's Q is a very good long term measure of the relationship between the market and replacement cost) eventually always brings the market back to fair value, but typically with an overshoot to the downside first (as the herd exits in mass, ignoring valuations on the way down just as it did on the way up). Biechele Royce Advisor (like GMO) increases allocations to assets and sectors AFTER they have dropped and decreases allocations to assets and sectors AFTER they have risen, in order to take advantage of a HUGE inefficiency in the markets created by career risk. However, we primarily let individual securities lead us to our over and under weights, using big picture considerations to provide a context for our valuation decisions. In other words, rather than making a broad call on an asset class, we instead do basic business valuation in order to buy good companies at great prices. Likewise we let basic business valuation drive our sell decision, making sure we exit a position once the company has returned to fair value.