Taking Irrationality Out Of Investing

Gary Stringer
Stringer Asset Management

In investing, you can think too big. What works for institutions doesn’t always pay off for the little guy.

“A lot of advisors say individual investors should try to act more like institutions,” said Gary Stringer, co-founder and chief investment officer of Memphis, Tennessee-based Stringer Asset Management. “But wouldn’t it be better if instead we adapted our investment methodology to acknowledge that we’re dealing with real people?”

Such is the thought process behind Stringer Asset Management (SAM), which blends modern portfolio theory and behavioral finance to create intelligent, globally diversified ETF asset allocations for financial advisors around the country.

The team originally began life as the internal asset management group at Morgan Keegan & Co., where they reviewed managers, mutual funds and ETFs, as well as managed portfolios for clients. After Morgan Keegan and Raymond James Advisors merged in 2012, however, Stringer and his team decided to go independent. Morgan Keegan signed up as SAM’s first client.

With Morgan Keegan behind them, they retained access to decades of research, a healthy asset base, and an established track record that went back to September 2008. “They were very supportive in helping us get started,” said Stringer. “Basically, we’re a startup that’s not a startup.”

What makes your approach to asset management different?
As investment guys, we’re firm believers in modern portfolio theory. MPT is a cornerstone of our investment process. But we also think it’s incomplete. Studies show investors tend to get about half the potential returns of the equity market, and even less in fixed income. We believe that the leading causes of that missed market opportunity are the mistakes we all make, the ones we’re all hardwired to make, because humans aren’t very good at dealing with financial markets. So we blend MPT with behavioral finance for a more retail-friendly solution.

How so? Would you give me some examples?
Sure. For example, retail investors don’t tend to do well with volatility. So we take a low-volatility approach, through the use of lower-correlation assets such as alternatives and so on, to help smooth the ride for folks. That helps people stay the course and increase the real return they can achieve.

We also try to avoid [very small] trades or positions. An advisor left to his own devices might put a 1% position into, say, Poland, because he thinks it’s a good opportunity. At the same time, he keeps the position small, because it’s risky. A small position size like that doesn’t really have a lot of impact on the portfolio. It does, however, create questions for the client.

If you meet with a client only a couple times a year, and you’re trying to focus on the big picture, and the first thing they do is flip to their holdings and see that their 1% in Poland got cut in half … suddenly that small position—which is not at all impactful for the whole portfolio—has derailed the entire conversation.

So instead, we try to cover the whole world with a balanced strategy using ETFs. That’s much more palatable for the individual investors and their advisors.

Are you primarily strategic or tactical?
Both, to an extent. We don’t take the institutional approach, where you do a mean-variance optimization and use all the assets all the time, just varying amounts. Instead, we take a strategic, three- to five-year view for the core of our allocation. Then we complement that with a 25% tactical allocation, where you’ll see more sector rotation, maybe, or specific ideas or individual commodities, etc. The strategic side keeps us on course, while the tactical element allows us to take advantage of opportunities or mitigate risk when we see the time and opportunity.

We also have developed what we call the “cash indicator.” This methodology signals to us the rare times when we should raise significant amounts of cash. We don’t do it often, because the more frequently you raise cash, the more frequently you end up being wrong. But there are times when you do want to be in cash. So the cash indicator serves as a circuit breaker, something to differentiate typical market volatility (like what we saw this past August), from something truly catastrophic (like the 2007-08 environment). It helps clients not act emotionally during times of duress.

Sounds like your whole philosophy is about helping clients not act emotionally.
Absolutely. A lot of folks say that institutions do better over time because they have a process in place, and shouldn’t we try to get individual investors to act more like institutions? But we turn that around. Wouldn’t it be better if instead we adapted our investment methodology to acknowledge that we’re dealing with real people? That, we think, is really the key to our success.

How do you use ETFs in your practice?
We use ETFs in a couple of ways. To manage a global allocation the traditional way, using individual stocks and bonds, would take literally hundreds of securities. That’s not very friendly to the investors trying to figure out what’s going on in their retirement accounts, or to the advisors trying to manage all these moving parts. So ETFs allow us to manage a global allocation effectively with far fewer securities.

Secondly, ETFs allow us to mitigate a lot of individual security risk. Is it Coke or Pepsi? What if you pick the wrong company? ETFs mitigate much of that. Being able to avoid individual stocks allows us to spend the majority of our time managing the most impactful part of the process: asset allocation.

How many ETFs do you use?
We own 15-20 ETFs, depending on the portfolio.

You use ETFs for your alternatives allocation. Which ones do you like?
That’s a space that’s been a good investment for us, especially in this environment where equity valuations are challenging. It’s nice to have another avenue to pursue.

One example that’s really worked out well for us is the PowerShares S&P 500 BuyWrite ETF (PBP | A-73), which is a covered-call writing strategy. Given the volatility in today’s equity market, we can now take some of that volatility and turn it into a return stream by covering calls.

Also, the First Trust Preferred Securities and Income ETF (FPE | D) has worked out very well for us. FPE is actively managed, so it shifts between variable and fixed preferreds. We really like that, especially in this environment. You can generate a little additional return and not take on the interest-rate sensitivity that you would have, if you’d had a passively managed preferred strategy. So even with the more recent volatility in interest rates for the 10-year [Treasury note], FPE has held up very well for us.

Have you encountered any major challenges in using ETFs over the years?
I wouldn’t call them challenges, exactly. But we’ve seen a lot of change in the ETF space and a lot of fad products. The ETF industry is no different than any other fast-growing industry. Take the late '90s, when, if you didn’t have an Internet fund, you were missing out. And now there are thousands of ETFs to sift through. So it’s just a matter of recognizing what the next big fad is and not chasing that.

What industry fads are you seeing right now?
Currently there’s a lot going around about currency-hedging strategies. I think they’re timely, but I don’t know how long-lived they’ll end up being. Also, a lot of new products coming out in fixed income are particularly frightening. Chasing yield is a very dangerous thing. I don’t think it will last. People will get burned on it.

But there are ideas coming up that are real, like factor-based investing. They call it “smart beta” now, but there’s nothing new about fundamental analysis, of course. The Fama-French model goes back a long way. So there’s nothing new about these factors, except that now there’s an efficient way to package them in a portfolio.

Looking ahead to 2016, what are your expectations for the coming year? Have they impacted your asset allocation?
Yes, they have. For the past 18 months or so, we’ve been starting to pare back some of our equity risk, because we think we’re in the later stages of the business cycle. We do think there will still be opportunities for investors to make money in equities, but risk management will be more and more important moving forward. So we’ve been reducing some of our beta exposures and eliminating some of our most volatile or aggressive positions. We’ve replaced them with lower-volatility securities.