The case for an all-domestic portfolio.

Efficient-market theoreticians have long maintained that there are two reasons American investors should invest some of their money overseas: diversification into non-correlated markets and exposure to an increased opportunity set. In my work as an investment advisor to American retirees, I have found these arguments wanting.

E Pluribus Diversificationis

After being dismissed by the New Economy cognoscenti as an anachronism, diversification has recently been rescued from the dustbin of financial history and reinstated as the one truly viable religion of portfolio management. The more non-correlated asset classes you own, adherents maintain, the less likely you are to be blindsided by a rout in your favorite investments. And the less likely you are to be faulted for straying from the performance attributes of some great, transcendent benchmark.

That's OK as far as it goes. But the advisor should realize that to base one's investment style on the importance of constraining volatility via maximum asset-class diversification is to subscribe to corollaries that you may not be so eager to embrace.

For example, are you prepared to state unequivocally that you are incapable of adding value to your clients' portfolios by the exercise of your judgment? (By adding value I mean reducing volatility, enhancing returns or both.) If that is your belief, you will enjoy the support of luminaries such as John Bogle, who is only lukewarm about the benefits of international investing, and other illustrious acolytes of indexing and efficient-market orthodoxy. But if you pledge allegiance to this creed, you must also be prepared to match fees with computerized allocation services, which can index and rebalance as well as you or better. Or else you will need to justify your fees almost entirely on the basis of non-investment services.

A Different Value Proposition

In spite of, or perhaps because of, my 38 years of experience as a professional investor, I remain an unapologetic proponent of active portfolio management. I believe that investment markets are more emotional than rational in the short run, which causes glaring inefficiencies in the valuation of entire asset classes from time to time. I believe that intelligent people who are experienced in the workings of the investment markets are capable, by the disciplined exercise of their judgment, to make better decisions with respect to the real value of asset classes (and securities, for that matter) than either amateurs or professional indexers who believe that they are incapable of making wise allocation decisions. I believe it is possible to perceive inefficiencies and to take advantage of them.

Think back to the last final two years of what we now call "the bubble." In your heart of hearts, did you believe that Nasdaq was worth 200 times earnings? Or did you really believe that valuation no longer mattered? If you did continue to ride the new economy rocket in those heady times, despite misgivings, my guess is that you stayed the course because that is what was working at the time; because you saw traditional value managers losing their jobs; because your clients were ecstatic; because the efficient-market cognoscenti convinced you, against your better instincts, that you could never know enough to go against the all-seeing "market." Rising prices made you feel like somebody knew something you didn't.

I think you can be better than that. I think you are capable of making a judgment that this or that asset class is or is not a good value, especially at valuation extremes. There are times when you can say with conviction that this or that asset class is or is not priced within a range that can be described as "normal." Looking back, if you realize now that you did know we were in a bubble, but did not adjust your portfolios because the efficient-market culture convinced you that you had no business making a call like that, then you are smart enough to add value by your investment judgment.

I also believe, that as a personal financial advisor to real human beings, you are capable of understanding clients' goals, expressing those goals in financial terms, and designing a portfolio appropriate to the achievement of those goals. All of these together-the listening, the translating and the investment judgment-constitute a value proposition that no computer can match, a value that justifies your fees.

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