The Art—Judgment Also Matters.

Think about it..if investment management were simply a function of data and data analysis then why would there be such disagreement among diligent, experienced analysts. The ‘art’ is the interpretation of both the data and, more importantly, existing expectations about the data.

Fact: Investor psychology and emotion plays an enormous role in the pricing of all tradable assets. What is fascinating is that crowd optimism or pessimism is self fulfilling most of the time, but nearly always wrong at extremes of either.

Opinion: Human beings are emotionally wired to be unsuccessful investors. History shows time and time again that investors chase what has worked well in the recent past and regularly push markets to valuation extremes, nearly always getting ‘sucked in’ at the top and ‘spat out’ at the bottom.

At Riverfront, we believe that over a 7 to 10 year timeframe, valuation, or the price you pay for an asset is the single most important determinant of your odds of being successful, but that investors will rarely give themselves or their investment manager 7 – 10 years to be proven right. Thus the art of investment management is to use judgment and experience to navigate the journey, lower volatility, manage risk and size the magnitude of different asset classes.

We use three rules to help us in this process:

Rule 1: Don’t fight the Fed.
We are constantly analyzing the actions and intents of policymakers in both the US and abroad. If policymakers are clearly intent on achieving a result, while markets often doubt their resolve or their ability to achieve that result, we take them seriously.

Rule 2: Don’t fight the Trend.
We try not to fight powerful trends, even if we think they may ultimately be proved wrong. We live by JM Keynes observation that “the crowd can remain irrational longer than you can remain solvent”

Rule 3: Beware the Crowd at Extremes.
As we mentioned above, if an extreme can be identified, especially when our Price Matters work confirms this extreme (stocks in the late 1990s, real estate in the late 2000s), then we need to be willing to lean the other way and to act aggressively once the trend changes.

These rules and our judgments are applied to our portfolios as tactical tilts away from our strategic benchmarks. These tilts are usually either opportunistic or part of a risk management plan. If we see an opportunity to be more exposed to a region, country, industry or an asset class because of valuation or our expectations for growth then we will go overweight. Equally, if we identify a short-term risk that might require some risk management, we will usually set an exit price level, or ‘stop loss’ level that we judge will break if the risk we have identified starts to become a reality. Our plan hope is that this will allow us to navigate short-term cycles while maintaining our primary focus on the long-term.