Dynamic Capital Allocation in a Covid 19 World

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“Is it possible to enjoy great diversification benefits without diluting performance? With Fenestra’s dynamic capital allocation model the answer is an unequivocal yes and herein lies a great opportunity for clients.”
By William Meyer

Let’s start at the beginning:

Readers will understand that more than ninety percent of a portfolios return stems from the capital allocation decision. Let me explain this with two extreme examples.

If we allocate all the capital to short term money market cash accounts the after tax, real (adjusted for inflation) return is guaranteed to be very low. This is an extreme allocation and interestingly the current return on Swiss Francs is a negative one percent. In other words if you invest in one hundred Swiss Francs at the end of the year you would be the proud owner of only ninety nine Swiss Francs.

Now on the other hand, if you invest all the capital in the “next Apple” your return will be stupendous!

Other Lego building blocks to blend into the capital allocation model include: Gold, American Dollars, other Dollars, and different countries and industries.

Over the years I have reviewed countless portfolios structured by institutional managers’ at large organisations. These portfolios often have the standard in house unit trusts, some ETF’s and some stocks, bonds and cash. When you drill down into these funds you find that they are actually indirectly invested into hundreds of companies’ sometimes easily more than five hundred different counters. The top 10 holdings in some of these portfolios have a total weighting of less than two percent. This means that the portfolio manager’s top picks represent less than point two of one percent.

It should be patently clear at this point that a point two of one percent of the portfolio in the manager’s top stocks is not going to move the needle even if these top picks perform very well.

In my opinion the top equity picks for a portfolio should have a weighting of at least five percent. Now if these stocks do well, and they should if carefully researched and bought with high conviction, we are really talking about serious out-performance.

On the other hand the seriously and terminally over diversified portfolios mentioned above can never mathematically outperform the benchmark because they are in effect the entire market. These are closet index funds masquerading as managed portfolios but they carry layers and layers of expensive fees.

This is the fundamental reason so many institutional clients have such an unhappy investment experience.

Preservation of capital is so important and a balanced portfolio must have an allocation to safe haven assets like the Swiss Franc and gold. For this reason the equity components must perform very well. After all, from a return point of view, they have to carry the entire portfolio as the return on the safe haven investments are going to be very low.

Some clients are horrified by the safe haven investments as they don’t provide much return but these are the life blood of the portfolio because they can fund the opportunistic and high conviction purchase of new equities. In a sense their relatively low return now will provide the greatest return as they are converted into special stocks.

Clients should never complain about cash! This will obviously, in a dynamic portfolio management process, provide the growth of the future.

Warren Buffett, the world’s most famous investor, says that diversification is for people who don’t know what they are doing. So review your portfolio carefully to check that you are not over diversified.


If you are not happy with your portfolio performance or would like a second opinion,
please do not hesitate to contact Fenestra for a free review of your portfolio.