Catherine Keating from Commonfund sat for an interview on Bloomberg earlier and had some interesting things to say. Commonfund provides portfolio management (and probably other services) to nonprofits, like endowments.

The money quote for me was that "diversification is about making your portfolio as efficient as possible." While endowments need to be managed differently than individual accounts the idea of efficiency is fascinating and something I have explored many times, though never framing it the way Keating did.

My introduction to the concept of portfolio efficiency came many years ago from a former colleague who was fascinated by the fact that for some period in the 1990's into the 2000's a portfolio of 98% cash and 2% short Nikkei futures gave the same return as the S&P 500. I used the word fact in that sentence but I can't vouch for the accuracy of his contention but true or not, it is great example of efficiency; market returns while risking very little capital (clearly a short position in any futures needs to be very actively managed).

One context for efficiency here has been the manner in which I take defensive action for clients when the equity market starts to roll over which in my estimation is how bear markets start (we're not there now). Any investor who is more of a buy and holder is likely sitting on some very large, unrealized capital gains in taxable accounts so selling for defensive purposes could neutralize much of the benefit of well-timed defensive action.

A small allocation to an inverse fund will grow in relation to the size of the portfolio if the market starts going down. Even with no sales this offers a reasonable chance of going down less. I am also interested in using one of the funds from AGFiQ along side an straight inverse fund. For now I would lean toward AGFiQ US Market Neutral Anti-Beta Fund (BTAL) but reserve the right to use something else when the time comes. Putting 3-4% in each fund plus a little bit to gold (which I maintain as a diversifier) and maybe one sale that isn't too painful, tax-wise, can go a long to seriously altering the extent to which a once fully invested portfolio looks like the stock market; efficiency.

She made another point related to smoothing out the ride (she didn't use that term) which is that it takes less time to recover from declines during the bear phase of the cycle. This is clearly relevant to investors in the withdrawal phase. Taking your full $30,000 or $71,000 or whatever might be more difficult while sitting on a 20% decline waiting for the market to recover.

Typically I have focused on the psychological benefits of avoiding panic via smoothing out the ride but this aspect is obviously crucial too.

Very useful interview.