“The less prudence with which others conduct their affairs, the more prudence we must use in conducting our own.”

 

-- Howard Marks’ favorite quote

As a portfolio manager, I have two jobs: 1) Define the playing field by understanding risk and 2) Once the playing field is defined, invest in opportunities that offer our clients the best risk adjusted return in order to achieve their goals. Last quarter we discussed our probabilistic approach in defining the playing field and understanding the dynamic of the risk/return tradeoff. This quarter I will update you on our thoughts on risk and share some thoughts on portfolio construction in light of these risks and uncertainty.

The double digit stock market returns we experienced in the first quarter should give us a reason to pause. Being 48 months removed from the financial crisis, we feel investors have developed unrealistic expectations for future returns, which will ultimately lead to disappointment. Given the prospects for future gains, we should expect that dividends will make up more than 50% of domestic stock market returns over the next 10 years. Meanwhile, bonds are underappreciated by investors. This is due to the expectation of rising interest rates. In our view, investors have forgotten the benefits of the liquidity and diversification that bonds offer. Lastly, as has occurred in Cyprus recently, when small and largely inconsequential events occur to the detriment of a few, it should serve as a sober reminder of the risks we regularly face as investors, especially when risks are largely ignored.