Defending Buy-and-Hold?

It is the age old debate:  buy-and-hold versus market timing.  Of course, these are actually the two ends of the continuum of actively managing the allocation among asset classes.  We all find ourselves somewhere along the spectrum, so it is unfair to demonize the extreme.

This discussion is prompted by an IN profile of Jeff Benjamin of the WBI Absolute Return Balanced Fund (WBADX).  The fund appears to be managed as a tactical asset allocation fund, varying asset class weights according to anticipated effects of economic conditions.  Not a particularly novel idea, and not exactly uniformly successful in execution.

We have all herd the pitches for buy-and-hold (BAH): market timing must show 70% success is necessary to break even versus BAH; all value is lost if the four best days in the market are missed; must be right twice.  these arguments are precisely accurate, but it doesn't ring totally true. n That is because these are answers to a questions that was not asked.


As I've mentioned before, Charles Ellis advocates for measuring performance against client-specific goals, rather than market indexes.  There are a lot of reasons, but the most important one is that it is the one that is of highest priority to the client.  Investment policy is then set to achieve the goal with the lowest risk portfolio.  Risk is determined by the portfolio's long-term asset allocation and is defined as the probability of missing the goal.  Over time, conditions will change, the portfolio will grow, valuations in the market will change, goals will shift.  The risk profile of the portfolio, and thus the asset allocation, changes only as a function of the return necessary to allow the current portfolio to meat the client goals.  The portfolio is not being managed to maximize performance. Therefore, tactical moves to take advantage of short-term trading opportunities are not contemplated by the policy.  To move away from the established policy is implicitly adding risk to the portfolio, because the portfolio is moving away from the lowest risk allocation that is expected to meet its objectives.

And this is where the middle of the spectrum comes in. When and how does the asset allocation get changed?  From a practical standpoint, all policies should include a rebalancing scheme.  Thus variance around the target allocation can be tolerated to a certain point.  Technically, it is calculated as the point at which shortfall risk exceeds trading costs. As so many trading costs are difficult to measure, a rule of thumb is usually adopted, typically 5% variance.

On the other hand, more strategic changes demand a great deal of work, Exactly the same work that established the policy in the first place.  And as this process is costly, in terms of time and effort on the part of the client as well as the advisor, the exercise does not take place often.  That is not to say that it couldn't, just that more frequent analyses are not cost-effective.

So that is how I come to defend Buy-and-Hold; not as a performance maximizing strategy, but as a low cost implementation approach to the lowest risk portfolio that will meet a client's goals.  There are other roads to reach the same destination and they each have their benefits.  This just seems to be one that is simple, cheap and effective.