Why Adapting Isn't the Same as Market Timing

When we describe our investment approach as adaptive, a question we sometimes hear is whether that's simply another name for market timing.

It's a reasonable question. Both approaches involve changing portfolio allocations as markets change. But the distinction lies in why those changes are made, how frequently they occur, and what they're intended to accomplish.

Understanding that distinction helps explain how we manage portfolios.

The Limitations of a Static Allocation

A common approach to portfolio management is to establish a fixed, or static, asset allocation. For example, a portfolio might target 60% stocks and 40% bonds, diversified across several asset classes, with periodic rebalancing to maintain those proportions.

There are sound reasons for this approach. It's straightforward, encourages discipline, and helps investors maintain a consistent level of risk. It also has a substantial foundation in academic research.

But a fixed allocation has limitations.

Traditional asset allocation often relies on historical relationships among asset classes, including their returns, volatility, and correlations. These inputs can provide a useful starting point, but they don't necessarily reflect the opportunities or risks present in today's markets.

Market conditions change. Valuations fluctuate. Asset classes that once offered attractive prospective returns may become expensive, while others may become increasingly attractive.

A static allocation generally does not respond to these changes. Instead, periodic rebalancing restores the portfolio to its original target, regardless of whether the relative attractiveness of its investments has changed.

We believe historical performance and diversification relationships are useful considerations, but they shouldn't be the only factors guiding portfolio allocations.

What About Market Timing?

The alternative to a static allocation is often assumed to be market timing.

Market timing generally involves changing investment exposure in anticipation of market movements. These decisions may rely on economic forecasts, technical indicators, or other signals, often with the objective of avoiding expected declines or participating in anticipated gains.

The difficulty is that consistently predicting market direction and timing is extraordinarily challenging. Even when an investor correctly identifies an overvalued market or an emerging economic risk, the market may continue moving in the opposite direction for an extended period.

Successful short-term timing often requires multiple correct decisions, including when to reduce exposure and when to restore it.

We are skeptical of strategies that depend on making these predictions consistently.

But rejecting short-term market predictions does not mean investors must maintain the same allocation regardless of changing valuations.

We believe there is a thoughtful alternative.

An Adaptive, Value-Seeking Approach

Our investment approach is adaptive because we believe portfolio allocations should reflect not only an investor's circumstances, but also the relative attractiveness of available investments.

The question we're asking is not, "Where is the market headed next quarter?" but rather, "What is this investment worth relative to what we're being asked to pay for it?"

This approach is supported by decades of academic research, including work by economists John Campbell and Robert Shiller, demonstrating that valuations can provide meaningful insight into long-term investment returns. Historically, markets with more attractive valuations have generally offered higher subsequent returns over longer periods, although the relationship is far less reliable over shorter horizons.

We apply these principles across asset classes and individual investments, seeking opportunities where prices are attractive relative to underlying value.

Valuations guide these decisions, with credit conditions, economic developments, and market trends providing additional context.

Our objective is different from attempting to predict the market's next move. It also requires patience. Valuations can change quickly, but the process through which markets recognize underlying value often unfolds over years rather than weeks or months. An asset class can remain expensive or inexpensive for an extended period.

We don't attempt to predict precisely when that relationship will change. Instead, we seek to position portfolios toward investments offering attractive long-term opportunities while remaining mindful of risk.

We are seeking value, not trying to predict the next market turn.

Value Is More Than an Investment Style

Our definition of value is not limited to what traditional investment indexes classify as value stocks.

These indexes commonly use measures such as price-to-book value, earnings, or cash flow to distinguish value stocks from growth stocks. Our assessment is broader.

A company with strong growth prospects may represent attractive value if its price reasonably reflects its future cash flows and other fundamentals. Conversely, a company with limited growth may be unattractive if its price is too high relative to its prospects.

The same principle applies across asset classes. What matters is not simply whether an investment is labeled value or growth, but whether its price offers an attractive opportunity relative to its underlying fundamentals and risks.

Adaptation Within Disciplined Limits

Adaptive investing does not mean making unrestricted changes to a portfolio.

Each client's portfolio begins with a baseline allocation designed around their financial objectives, investment horizon, capacity for risk, and comfort with market fluctuations.

From that baseline, we make measured adjustments to stock and bond exposure within established ranges as valuations and investment conditions change.

These adjustments can be meaningful, but they are not all-or-nothing decisions. Our objective is to remain invested throughout market cycles while adapting portfolio exposure to reflect changing opportunities and risks.

We believe this combines two important principles, a disciplined long-term investment strategy and the flexibility to respond when market conditions warrant.

Recognizing the Trade-Offs

Adaptive investing involves trade-offs, and we believe those deserve acknowledgment.

In a strong, sustained market rally, a portfolio that maintains less exposure to expensive stocks may underperform one that remains more heavily invested. Expensive assets can become more expensive, and valuations alone provide little indication of when that trend might reverse.

As a result, a valuation-sensitive approach can experience extended periods of underperformance relative to a static allocation.

There is also no assurance that investments we consider attractively valued will ultimately perform as expected, or that changes in allocation will improve returns or reduce losses.

We accept these limitations because we believe the relationship between price and underlying value is an important consideration in managing long-term investment risk.

Our objective is not to outperform in every market environment. It is to make thoughtful allocation decisions based on the opportunities and risks we see, while remaining consistent with each client's long-term financial goals.

The Difference Between Adapting and Timing

Skepticism about market timing is well founded. Consistently predicting short-term market movements is difficult, but avoiding market timing does not require ignoring valuations or maintaining an unchanged allocation through every market environment.

We believe portfolio management can be both disciplined and responsive.

Our approach uses valuations to assess long-term opportunities, makes measured adjustments rather than dramatic shifts, and operates within risk limits established for each client.

We don't attempt to predict when markets will change direction. We seek to recognize when the relationship between price and value changes enough to warrant an adjustment.

That's what we mean by adaptive investing.