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This episode aired on BloombergTV on Dec 12, 2012

Time Horizon
Diversification

Time Horizon Diversification is an important concept to incorporate when constructing a panoramic portfolio, and requires understanding that different investments operate on different time lines, should be considered in different time frames. Intuitively this seems obvious- artwork doesn’t appreciate over night, and timberland requires time for trees to grow before harvesting- but when crisis strikes the urge to flee to the safety and liquidity of cash or bonds may be overpowering. Further, in such extreme situations as financial crises, there is a high premium offered to those who have the discipline and resources to stay invested in less liquid asset classes. Thus the portfolio properly diversified across time horizons will be able to weather crises and even capture alpha while most investors run for safety.

Q: The phrase “Time Horizon Diversification” is one that seems to mean different things to different folks. Tell us about it.

A: Right: to me, one use of the term is an important idea, and the other is a retail stockbroker sales tool. The way in which I think its an important idea is this: During times of high anxiety, people tend to pile in to hyper liquid assets, like US Treasuries. Those assets therefore become relatively expensive; there’s a big liquidity premium. So less liquid assets can become comparatively cheap, and potentially quite attractive. Therefore, if you think about diversification as having a liquidity time dimension (and have the resources to do so), instead of just the asset dimension, you could be better off in the long run.

Q. So, by “Time Horizon Diversification”, you don’t mean simply “buy and hold” stocks, or simply time-target more traditional financial investments?

A. Exactly, very, very important. Some stockbrokers use this term to justify various stock market strategies. In that case, I see the term as a fairly useless sales tool. After all, nearly all financial assets essentially behaved the same way in the last crash, regardless of how long the investor intended to hold them. Instead, we’re talking here about assets that inherently do have a longer liquidity time frame, for example, infrastructure investments, and other “real” assets: land, art, mines, timber, water, etc. A sort of “30 Years War” portfolio, things that tend to hold value over a very long time… but, are illiquid in the short term.

Q. What do we need to especially watch out for with these sorts of assets, aside from the obvious one that they should only be made with money that we won’t need anytime soon?

A. Most important to me are the issues around investing in these sorts of assets in foreign jurisdictions that don’t share our history of the rule of law or stable institutions. Often, those countries offer big growth opportunities and long term appreciation, but you can be subject to a lot of political risk.

Q. But, overall, you’re saying that (properly defined) Time Horizon Diversification can help an investor generate alpha?

A. I think so. Obviously, generating alpha in highly liquid investments is the best of all possible worlds. But , being realistic, that can be extremely difficult, especially in times like this when everybody is piling into the same liquid strategies. Therefore, when anxiety is highest, the low-hanging alpha, so to speak, can often be picked from the more illiquid trees.