Innovation happens when old ways of thinking and long held assumptions are challenged. An accelerating number of new tools and methodologies are rapidly coming into the world of traditional asset management and are spawning new approaches in managing portfolios and risk. To explore where this new environment is taking some money management firms, the Institute for Innovation Development recently talked with Tom Hardin, managing director and chief investment officer of Canterbury Investment Management—an investment advisory firm specializing in providing financial advisors, institutional investors, and retirement professionals with an adaptive ETF portfolio management solution built on defined rules and evidence-based results. Focused on their proprietary Portfolio Thermostat Strategy and The Portfolio Thermostat Fund (CAPTX), Tom warns advisors and other money managers about the risks in not challenging “conventional wisdom” and positioning themselves to take advantage of a new era of investment innovation and opportunity for investors.
Hortz: Why do you characterize today’s investment environment as an unprecedented time of innovation and a new age of enlightenment?
Tom Hardin: Today, we have access to virtually unlimited computing power and equally robust software algorithms that are designed to process big data and uncover hidden, relevant information. The early adoption of new cutting-edge technologies and enhanced operating systems usually leads to massive disruption of the status quo and traditional ways of thinking. These technologies open a gateway to new horizons of possibility and prompt a re-examination of all our assumptions, theories and methods being currently used.
We feel strongly that we have entered a new age of financial enlightenment that will lead to a seemingly endless stream of new information and innovative product creation like the development of highly unique exchange-traded funds. When new technologies are combined with equally robust adaptive portfolio strategies, then innovation can thrive, making it possible to better manage a portfolio through any market environment—bull or bear.
Bill Hortz: With the advancement of new investment tools and changing investing paradigms, why do you feel that most asset managers still depend upon outdated methodologies and resort to the same old approaches?
Hardin: Traditional portfolio management was built based on theories and beliefs that were formed 30 to 50 years ago. The primary challenge for portfolio managers has been to overcome the years of ingrained “conventional wisdoms” that have become unquestioned truths. Overcoming these conventions requires a whole new way of thinking that will, often times, fly in the face of existing beliefs. Those individuals who lack a compelling vision of what the future could be are more likely to be slow to adapt to change and risk becoming obsolete. Remember that conventional wisdom is the enemy of innovation.
It is also important to note that advancements in new technologies and tools only have the “potential” to create change. The full benefits of any new technology will not be fully realized until a learning curve of trial and error is complete, and the creation of new applications have had a chance to catch up.
Hortz: Can you walk us through an example of an incorrect assumption being widely used by investment professionals?
Hardin: Let’s begin with the universal assumption that drives the way portfolio managers and investors invest—the risk/return relationship. This is driven by a common belief, perpetuated by the old theories, that given enough time, the willingness to assume more risk is required in order to produce higher returns. The relationship hinges upon the acceptance of a tradeoff—invested money generates higher profits only if subjected to higher risk. Low levels of risk only entitle you to low potential returns.
The risk/reward proposition is an assumption born from business. A business owner, or potential business owner, would first assess whether or not a business decision was worth making. He/she would evaluate the capital and the timeline required in order to determine the risk of the decision. A business decision that required more initial capital, or a longer timeline, would require a higher potential return to compensate the business owner for the higher level of risk.