Imagine creating a map 250 million years ago during the supercontinent phase of Pangaea. At this point, you are probably long overdue for an update. Similarly, there is a paradigm shift that is taking place among the investment management community. It is evolving slowly and growing out of necessity. Let’s refer to these strategies as “traditional” and “new normal.” I only suggest “new normal” because it is an already popularized phrase used to describe a time period with a new landscape. The difference between portfolio strategy from the traditional perspective and the new normal perspective is constraint; time constraint, weight constraint and, most importantly, mental constraint.
With time constraint, I’m referring to holding periods with long-term philosophies. With weight constraint, I’m referring to maximum mandated percentages of particular holdings or asset classes. What establishes the prior two obstacles is an emphasis on history; an emphasis that constrains the possibility of what a portfolio structure should resemble in the future. If this is a new normal economic period, it stands to reason that portfolio strategy should be redefined as well.
So let’s redefine it. We could start by allowing ourselves to think outside the box–just a little. First, let’s add the words “dynamic” and “flexible” to all defined investment concepts (diversification, core/satellite, risk, etc). And if we allow for limitless possibility by removing the mental constraints, we can only partially describe these terms. What is dynamic diversification? It is the ability to hold only a few positions or many positions. It is the ability to hold concentrated positions and diluted positions. It is the ability to move between sectors, countries, or themes with efficiency. It is the mandate that holding periods should be very short or very long. It is very strict rules and no requirements at all. It is everything and it is nothing.
I am not suggesting that you can define these terms however you please. I am not suggesting that as long as you have a definition–and stick to it–you will be profitable. Quite the contrary: your definitions have to change over time. Strategies that are stagnant with the definition of what they should be, will fail. Strategies that adapt, evolve, and modify themselves based on market conditions, will succeed.