High Time Preference Investment Advisors?

This morning I sat in on a great ETF-themed virtual conference put on by ETF Trends, Investopedia and ETF Database. It covered a lot of ground with a lot different guests/viewpoints. 

There was one takeaway that was probably unintended but very useful. There were a lot of audience questions and sponsor polls that focused on themes for 2022, ETFs for 2022, this for 2022, that for 2022 and so on. Harsh comment coming but if you are making portfolio decisions with other peoples money based what you think might happen in a given year, then you're doing it wrong.  

Portfolio changes need to happen of course but waking up on January 1st and making a guess that, I don't know how about, self driving cars will become more important for 2022 and be a market leader is guessing (repeated for emphasis). Self-driving cars, the metaverse and other narrow themes will take much longer to come to fruition to change how society does things. Funds in those themes, or other "hot" themes might have a great 2022 or they might be lousy performers, I have no idea and neither does anyone else, we'd all be guessing. If we're guessing, if we're making a bunch of guesses then some of those guesses will be correct of course but many will not. That's tough way to have long term portfolio success.

Contrast that approach to a holding I added in Q2, 2021 with SPDR S&P Metals & Mining ETF (XME). It seemed pretty clear that the risk of price inflation was escalating. A fund like XME, and there are many of them, should do well in an inflationary environment. To me, that's what active management is. Observing the risk of something, like inflation, going up or going down or observing the visibility for a fundamental tailwind for some theme that should last for years like maybe Web3. 

What is the risk consequence then for making some sort of allocation to a theme like reopening travel or to some economic threat? Getting the reopening wrong could be very painful in the short run but is there any doubt the world will reopen? No, there is no doubt but I have no idea when it will happen and so guessing on that is not my trade. Contrast that to supply chain problems, distortions in the labor market, degradation of worker productivity, some sectors of the economy not functioning properly, runaway asset prices and anything else you can think of and it is easier for me to conclude, the risk of inflation increased markedly. 

Back then the outcome could have been no uptick in inflation but the risk elevated and client portfolios could be adversely effected by higher price inflation. The risk of being wrong with XME is more cyclical as opposed to threat as an ongoing concern. If travel is shut down long enough, the airlines eventually fail. The consequence of the risk of missing the reopening is far less than the consequence of the risk that price inflation gets away from us. 

Advisory clients often want to know what I think will happen for the year. I certainly don't know but I can talk about what risks are elevated, how to prioritize those risks and whether or not we need to do something to mitigate the consequences of those risks. Mitigating the risk of inflation is one I wanted to protect against, and still have protection against. Supply chain disruption is another one I've taken step to protect against albeit a little more broadly on that one. The way the portfolio is constructed these days, there's not much need to protect against a travel shutdown because we don't have meaningful exposure to that industry. 

The other drawback to the high time preference of "what's hot for 2022" is that you move away from the ergodicity of letting the market or certain sectors or certain stocks work for you, compounding dramatically over the long term. I made two purchases in the carnage of Q4, 2008. One of them I still own, the Consumer Sector SPDR (XLY). I bought it in the $18's and today it is at $204. As Tony Kornheiser might say: that's ergodicity Holmes. In a reasonably diversified portfolio there's a good chance that you'll have two or three of these when looked at a similar time horizon. And even if you don't use narrower holdings, the S&P 500 is up 250% in the last 10 years. 

I've been writing about this concept since long before I knew the word and am convinced it is crucial to long term investing success. Years and years ago I said it would be great to build a portfolio so perfect that nothing ever needs to be sold. That would be great but I don't think it is realistic. Inflation wasn't a problem (for many years) until it was a problem and like I said, I think risk of inflation is something to address.