If you’re looking to improve your long-term portfolio performance, try thinking more like an NFL head coach.
Coaches design their football teams to win championships by focusing on consistent performance in any environment. Their teams are composed of 3 highly functioning units:
- Offense, tasked with putting points on the board for your team
- Defense, tasked with keeping the amount of points other teams score low
- Special teams, tasked with a myriad of other important functions, from kickoffs to punt returns
The key to this highly-functioning team is that when one unit is struggling, the others are there to pick up the slack. Not all players on your team work at the same time or in the same way.
Why? Because good coaches know that not every player on the field has to be scoring major points to be effective overall. Coaches know that it’s not about the points each player scores, but whether at the end of the game they’ve got a W or an L by their team’s name.
Investors, however, tend to forget this when they go to build their portfolio teams.
Rather than diversifying the kind of players they have – most effectively done by allocating to investments that access different types of risk – they chase individual performance. Rather than building a roster with effective offense, defense and special teams, they look for whoever scored the most points last season and buy them out of their contracts, usually way above market rate.
As the coach of your own portfolio team, you can build a set of players that have chemistry. In investment terms, chemistry equates to correlation. You want a team where different players are scoring, blocking and tackling at different times. Why? Because perfect performance from one asset doesn’t always add to the kind of chemistry that means a win at the end of the game.
All you have to do is think like a great coach and build a three-part team that includes:
- Stocks, tasked with being your portfolio’s offense, the engine for scoring performance points
- Bonds, tasked with being effective portfolio defense, as long as investors stay with bonds that have historically provided diversification against stock market moves
- Alternatives, tasked with a host of other important functions like special teams, ranging from minimizing maximum drawdown to lowering volatility and even adding to returns as well
This kind of diversification can be a profit center as long as you draft enough offensive, defensive and special teams members to set up your team for success.
Yes, diversification helps save your bottom line by putting different eggs in different baskets (the way your special teams would help preserve your field position on a hard fought drive). However, because each part of the team is taking different kinds of risk, they are all scoring at different times. This can provide a higher rate of return—like when you let strong special teams players run back a great punt for a touchdown occasionally while still relying on your quarterback to set the pace for the game.
By creating a diversified portfolio team that takes a variety of risk, you put yourself in the best place for a line-up that can perform against a variety of opponents. So, not only could you gain outsized performance from players that historically have done well, you no longer need to worry about tweaking your line-up before every tough game. Just let your players perform the way you want them to.
Article by Stephen Scott, Longboard Funds