Process Over Outcome part I

James Pope |

DIS and DAT- Process Over Outcome part I- Winter, January 2014

Our periodic communication that reminds you to ask, “Should I react to those headlines?”

 “Worry about today’s effort, not tomorrow’s results.”
- John Wooden 


Dear Friends:

            Over the past year the U.S. equity markets have delivered returns well in excess of historical averages.  The end of one year and the beginning of another is a time for investors to review their returns and make new commitments to change.  In this industry, typically a process likely to become a race to the bottom begins at this time.  The negative loop starts by investors and consultants placing too much emphasis on recent past performance.  Here are several examples:

  1. Consultants firing the worst performing investment managers and selecting hot managers as replacements.
  2. Investors firing their consultants and selecting someone seeming to deliver higher returns.
  3. Investors telling their consultants to sell their underperforming investments and replace them with better performing ones.
  4. Do-it-yourselfers and investment managers becoming overconfident, yet forgetting to check the risks in their portfolio. Possibly making moves that increase the risks, because they are so confident.

The solution to avoiding this downward spiral is to focus on process.  In most situations there are at least two layers of management between the investor and the investment.  For this report let’s refer to them as consultant and investment manager.  As a firm DIS performs both functions.  Overall there are at least three processes which are important to the investor.  The first, which we will discuss today, is the process of selecting a consultant.  The second is the process the consultant uses to select investment managers.  Since, DIS is the consultant and the investment manager; we will not discuss this process.  The third is the process of investment selection.  Our process of investment selection will be discussed next time.

            For purposes of this report, the term “consultant” will be defined as anyone sharing information with the investor. This could be a reporter, a newsletter writer, an author, a guru, a next door neighbor, a relative, an advisor, a representative, an investment manager, etc.

            The relationship between investor and consultant is extremely important to the ultimate investment results. This report lays out an alternative to the selection of an investment consultant based primarily on performance. An emphasis placed on understanding the process over the outcome may serve an investor better over the long-term.  The reason is that past performance was someone else’s return, which will differ from the investors, and future performance is only “hoped for.” Now let’s take a look at a process for consultant selection.

            From the investor’s perspective, a few points on where not to begin the evaluation of a consultant could be helpful. Keep in mind that the investor has a role to play in the performance of the account.

            Popular methods, which may not work out well, if sought before understanding the process include:

  1. Performance figures
  2. Likeability of consultant
  3. Popularity of consultant
  4. Services of the consultant
  5. Fees

            Obviously these five factors may play a role in the process; they just may not be the most important in determining the future satisfaction of the investor.

            The process below is divided into four main areas.  This is not meant to be an all-encompassing list.  It is meant to be a foundation which allows an investor to take a step back from the “pitch” and think deeper before taking action.

I.) Avoiding worst case scenarios

A. Begin with realistic expectations.  W.C. Fields had a movie titled, “You can’t cheat an honest man” which comes to mind. An investor with reasonable expectations can help avoid getting involved in “too good to be true” scenarios.  Knowledge of the current ten year treasury yield and inflation rate can form a basis to review the pitch for reasonableness. All investments will go through periods of relative underperformance or disappointment.  An investor should seek to understand what type of environment may cause the relative underperformance. Typically being able to properly identify that period and being able to maintain the investment through it will be the most important determinant of your success. This can be the true value of a great consultant.

B. Conduct due diligence on the custodian.  The custodian is the company holding the funds. A business model where consultant, manager, and custodian are one in the same has brought problems in the past. The investor should receive direct communication from the custodian.

II. Matching incentives

A.  The way the consultant is paid can provide information on their incentives and whether that incentive matches the investor’s goals and objectives. The media has a certain agenda, as well as product sells, asset gatherers, financial planners, and investment managers.  Friends and family who are well-meaning charge no fee and have little incentive for deep research, and monitoring etc. The multiple forms of consultant compensation can lead to difficulty in comparisons. This is why understanding incentive prior to attempting to figure out the amount may be important in narrowing down the list of prospective consultants.

B.  Knowing YOUR investment objectives BEFORE listening to a consultant could be helpful. This will allow you to have a better idea of whether a consultant matches your objective, instead of vice versa. Usually an investor will have multiple time frames for needing their money, which will lead to multiple investments. One size fits all is rarely the answer when constructing portfolios.

 III. Matching philosophies

A.  Use of the word diversification has become popular when discussing investments. Ask for more information regarding what a consultant means by diversification.

  1. What is the position size of each investment position?
  2. Do you incorporate multiple risk drivers into the portfolio?
  3. Do you diversify over time, or invest it all at once?
  4. Do you diversify over time horizons such as short, mid and long term?

B.  A meeting focused on discussing your investment objective should take place prior to investing. This meeting should include discussions on risk and acknowledge multiple possible environments occur over the long term.

C.  Most successful strategies have a core concept of either trend following or reversals.  The mindset is very different for each.  The ability of both the consultant and the investor to maintain the course in the most difficult periods of each will go a long way in determining the future results.

D.  Many investment solutions are pooled money. Knowing whether the consultant places money in the same investments as prior clients received instead of analyzing each position for appropriateness at the time of entry may be important. An example is purchasing for client A investment XYZ and then after a large price increase also purchasing that investment for client B several years later may not be what the investor desires.

IV. Feedback and monitoring

A.  How often the consultant reviews the portfolio with the investor may be important. This naturally throws out most authors, talk show hosts, popular gurus, family, and neighbors etc.

B.  A minimum report should include the beginning value, fees incurred, withdrawals or additions, and the ending value.

            Once an understanding of how the consultant handles these four areas has been reached, it is then logical to move on to understanding the services, fees, performance, as well as any other criteria which the investor believes is important.  Coach Wooden’s quote above combined with his “Lesson #11 Don’t look at the scoreboard” may provide sound guidance for the process an investor should consider when seeking out a consultant.

            We look forward to sharing with the investment process DIS uses next time.

See you next time.


James Pope

Please remember to contact Diversified Investment Strategies, LLC dba Advisor.Investments, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you want to impose, add, to modify any reasonable restrictions to our investment advisory services, or if you wish to direct that Diversified Investment Strategies, LLC DBA Advisor.Investments to effect any specific transactions for your account.  A copy of our current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Diversified Investment Strategies, LLC dba Advisor.Investments), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Diversified Investment Strategies, LLC dba Advisor.Investments.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Diversified Investment Strategies, LLC DBA Advisor.Investments is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  If you are a Diversified Investment Strategies, LLC dba Advisor. Investments client, please remember to contact Diversified Investment Strategies, LLC dba Advisor.Investments, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Diversified Investment Strategies, LLC dba Advisor.Investments current written disclosure statement discussing our advisory services and fees is available upon request.


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