"No Mr. Bond, I expect you to die!”

Auric Goldfinger points a very slow-moving laser pointed at Bond’s asset allocation.[/caption]

I’m going to come right to the point. In today’s market, bonds are unable to provide the value proposition to portfolios that they have historically offered—we’re seeing very low yields at very high prices—a near guarantee that you’ll be buying high and selling low. Until this situation corrects and gets back to some sort of normalcy, we are making changes to our asset management strategies across the board. Our thinking on those changes is laid out below.

Conventional wisdom is that you increase your exposure to bonds as you age, protecting downside losses and trading the principal risks of equity returns for the certainty of fixed income. The “rule of thumb” equation in advising has long been that most folks should own “100 minus their age” in equity and put the rest in fixed income assets. Right now, we think that’s a terrible idea. In our view, the only certainty you will get from that approach, is drastic underperformance. Following standard advice will give you terrible results when following lemmings off a cliff.

Remember when your parents asked, “ if your friends jumped off a cliff would you follow them?” Sadly, most investors say “yes.”

Bond yields so low that it can take 500 years to earn back your principal. That sucks.

If you want to go deeper on a bunch of the thinking behind where we’re at on bonds, I’d highly recommend you read this piece from Ray Dalio, the founder/CEO of Bridgewater, the world’s largest hedge fund. Dalio lays out the macroeconomic argument and recommends how people should position themselves to avoid the brunt of a correction which could come at any time, and which will likely take years (maybe decades?) to work through. We are at the tail end of a forty year cycle in bonds, where yields have dropped to almost zero and prices are about as high as they can get. Meanwhile, we’re also beginning the giant demographic shift of baby boomers entering retirement. This will likely not end well. Yields have to eventually climb from here, and they will be offset by price drops. We’ll have to see how comfortable people feel when they start watching the “safe” parts of their portfolios lose significant value. In our view, things will get worse in bonds before they get better. Suffice it to say that I buy into the premise of Ray’s thesis, so I’m just going to focus on what we’re actually doing to respond to it.

What is Prospero Wealth doing?

• In our “passive” strategies, we are cutting our bond exposure by 50% across the board. A 60/40 will essentially be an 80/20, for now (but we will maximize diversification given the options we have).

  • We will add to our Real Estate positions and skew more global. You will see a larger allocation to investments explicitly outside of the US, in many cases equal-weighting them.

  • For portfolios that are meant to be 60/40 (or more conservative), we will use the minimally tilted offerings available from Dimensional (we currently use a slightly more aggressive tilt). While your 60/40 is an 80/20, the stocks within that allocation are allocated with a heavier focus on value and profitability (towards a conservative approach).

    • Just as a reminder, Dimensional Funds, which we use exclusively in our passive portfolios, is a proprietary set of products, only available through approved advisory firms. They differ from standard index funds in that they overlay certain quantifiable criteria (value, momentum, etc.) that allows them to differ from standard market-weight or equal-weight indexes. The extent to which they differ is their degree of tilt.

  • For portfolios that are meant to be 80/20 (or more aggressive), we will use the maximum tilt available from Dimensional (we currently use a slightly less aggressive tilt).

• In our active Growth and Long-Short SMA strategies, we’re not going to have any bond exposure. We started our Growth SMA with some basic bond indexes adding ballast. We’ve pulled that out. We may actually go as far as to short bond funds in the Long-Short. It is something we are actively considering.

• In our custom strategies, we will also be minimizing bond exposure using similar means.

What should you do as a client?

• In most cases, nothing (other than be prepared for higher volatility).

• If you have ongoing cash needs or expect to start sustained withdrawals within the next 5 years, talk to us about building a custom allocation. We have a number of clients withdrawing funds quarterly, earning 2.8%-5.6% on their principal (while accepting some measure of principal risk).

• If you have a significant chunk of your assets indexed passively, think about carving out some of that allocation to go more active with it. In our view, the market ahead is going to provide us plenty of volatility and the associated opportunities to zig while most money zags.

How long will this last?

• Indefinitely. Until something definite happens.

As always, Marcus and I are here to answer any and all questions that you might have. We consider it our duty to protect and maximize your assets over time. Rest assured that we are right in here with you, making these changes across our own portfolios alongside yours.