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Warren Buffett

Portfolio > Portfolio Construction > Investment Strategies

Portfolio Strategy Zooms In on Buffett's Market Tactics

By John Manganaro

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What You Need to Know

  • The approach emphasizes reassessing asset mixes throughout market cycles.
  • The key to the strategy is buying fear and selling greed.
  • However advisors choose to manage clients' retirement funds, it will always be a balancing act.

A new portfolio management technique developed by the investment team at Dunham & Associates aims to complement traditional bucket strategies and partial annuitization to help retirees address both longevity concerns and sequence of returns risk.

The so-called “DunhamDC” strategy operates according to an algorithmic management approach, said Salvatore Capizzi, an executive vice president at Dunham. The technique seeks to implement Warren Buffett’s portfolio management advice: “Be fearful when others are greedy and greedy when others are fearful.”

In practice, Capizzi said, this means consistently rebalancing portfolios throughout a market cycle in order to own fewer stocks when the cycle hits a high and more stocks when it hits bottom and begins its way back up.

“It’s not about market timing,” Capizzi emphasized in a recent ThinkAdvisor interview. “It uses an algorithm that is unemotionally based on math and time. It eliminates complicated strategies and human emotions.”

The strategy has been tested over several years as a portfolio overlay, Capizzi explained, and the firm formally launched DunhamDC as a public investment option in April.

The fund is offered as part of an advisor-led retirement income planning program that features other funds with complementary objectives, including emergency spending, health care spending and legacy planning.

While he is excited about Dunham’s specific strategy, Capizzi noted the importance of advisors understanding that their retirement clients face a balancing act when it comes to managing their portfolios.

“The sting of sequence risk stems from the fact that the very asset class that can protect retirees from inflation and provide necessary long-term growth for increased longevity — equities — is also the one that could deplete their savings prematurely due to the sequence of returns,” Capizzi explained. “Add higher inflation to the picture and it’s a really tough challenge.”

Advisors who can navigate these countervailing pressures, he said, will shine in the eyes of clients and prospects, while those relying on outdated techniques could find themselves losing favor.

The Retirement Journey

Three factors define the retirement investment challenge, Capizzi detailed. These are inflation, increased longevity and sequence of returns risk.

“As financial advisors, managing these interconnected risks is crucial for any well-constructed plan,” Capizzi said. “The paradox lies in how these factors influence retirement planning and what helps one factor can potentially devastate even the most carefully planned plan.”

Echoing his recent blog on the topic, Capizzi likened the fight against these considerations to the effort to sail from California to Hawaii with enough supplies to last the journey.

Inflation can be thought of as a constant headwind, steadily pushing against the ship, making progress harder and requiring more supplies — money, in the case of retirement — than  anticipated.

Extended longevity, in turn, is akin to discovering mid-voyage that Hawaii is farther away than originally thought. So, the supplies must last for a longer journey.

Sequence risk, finally, represents unpredictable storms during the voyage.

“If a major storm hits and you have poor sequence of returns in the first few years of retirement, it can damage the ship and deplete supplies — making the rest of the journey precarious,” Capizzi explained.

Traditional Merits and Drawbacks

Advisors have a variety of traditional approaches to address this proposition, Capizzi noted, and each has its merits and drawbacks.

Building bond ladders is one useful technique, for example. A properly constructed ladder can provide interest income at regular intervals, and that income is generated while the bond ladder helps minimize interest rate risk by holding the underlying bonds until maturity.

That said, the likelihood of future rate decreases poses challenges. Another issue is the high workload involved in reinvesting maturing bonds, and it’s all too common to see advisors implement in inefficient or inconsistent methodology.

Bond ladders, further, can struggle to generate sufficient yield for longer retirements and lack growth potential to address longevity.

“Modern retirement strategies require a growth component, often involving equities, to combat extended retirement periods and inflationary pressures,” Capizzi argued.

Bucket strategies also have merit when it comes to mitigating sequence risk. They do so by allocating funds across multiple time-horizon portfolios, ranging from highly liquid short-term buckets to longer-term investments.

Again, such an approach is effective against sequence risk and does provide a degree of growth, but this approach may also fall short for modern retirees.

Finally, annuities provide steady income while addressing sequence risk regardless of market conditions. However, they often fall short of longevity and inflation risks, Capizzi noted.

Growth-Oriented Complement

Capizzi argued that the DunhamDC approach offers an effective growth-oriented complement to the three traditional approaches.

“It accomplishes this by adjusting its equity exposure in a highly disciplined way, increasing it during market declines when stock prices are lower, and subsequently selling portions of its equity holdings during market upswings and price increases,” Capizzi said. “In our view, this is the complete opposite of what most investment strategies do.”

That is, many managers own heavier stock allocations when the market cycle hits its high, and fewer or no stocks when the cycle hits bottom. This approach may provide higher absolute returns in some fast-growth periods relative to what Dunham delivers, but it also leaves retirement investors exposed to untimely downswings.

In the end, Capizzi argued, the advisor’s goal is not to eliminate risk entirely but to manage it to align with each client’s circumstances and objectives.

(Photo: Bloomberg; Illustration: Chris Nicholls/ALM)

John Manganaro

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