By Jerry Wagner Jazz has been a part of my life since the 1960s. I’ve always loved the combination of individuality and collaboration that is specifically a part of the modal, hard-bop version of traditional jazz. The focus is on snatches of a song’s melody captured by the various members of the trio, quartet, or quintet playing. The instruments are separately featured as each musician has their own take on the tune within a limited chord structure. However, no matter what musical heights the individual takes us to, at the end of their part, it is back to the group as a whole. “Classical” portfolios vs. “jazz” portfolios Investment portfolios are often compared to music. I’ve even heard portfolios referred to as a symphony. This may be apt. Yet, while traditional asset allocation may be analogous to a symphony, modern portfolios need to be closer to jazz. Classical music focuses on accurately playing the composition as it is written. It is judged by the degree to which the orchestra members adhere to the musical score. Similarly, traditional asset allocation focuses on how closely each element (asset class) adheres to its assigned benchmark. In contrast, jazz is all about the individual performer’s interpretation of the music and his or her ability to ultimately integrate that with the other members of the group. Both the symphony and the jazz group are judged by how the whole work sounds, yet they differ in how they reach that end. Just as jazz differs from the symphony, portfolio construction using strategies instead of asset classes is different. Like the jazz performers, the individual strategies reflect their own personalities. They may use one asset class, like in a stock strategy, but they do not perform in the same manner as an asset-class benchmark. Like a talented jazz musician, the strategy picks up the theme of the asset class. But it also drifts away from it in asserting its personality. If it is a trend-following strategy, it will stick with the trend while it predominates but then move to an alternative defensive asset class when the trend wanes. If it is a contrarian strategy, like the short notes played as counterpoints to the overall melody in a jazz performance, it will zig when the asset class zags, seeking profits in quick bursts of activity from countermoves in the price of the asset class. Whether that is a good strategy is determined by its profitability at the end of a complete market cycle and how it works with the other strategies in the portfolio. This collaborative interaction element, which is so important to traditional jazz, is essential to portfolios of strategies, even more so than portfolios of asset classes. The benefits of synergy Like performers in a jazz quintet, different strategies will perform at different times. And just as you would not want to listen to a piece played with a single note from a solo instrument, the beauty of jazz and of a portfolio of strategies comes from the combination of each musician’s performance. This is why we continually emphasize the importance of combining uncorrelated strategies in a portfolio. They must act differently from one another to ensure that one musician (strategy) keeps performing when all of the other performers (strategies) have ceased playing (stopped performing). If all of the strategies in your portfolio are moving higher or lower together, that portfolio is not uncorrelated. You must cultivate the outliers, the unique individual performances, to end up with a portfolio that can deliver virtuoso performances on any stage. Again, the asset class just has to stick to the benchmark, often simply by buying the benchmark. In contrast, like a jazz musician, each strategy must individually wend its way in and out of the benchmark, and then finally find its way home to profits at the end of the cycle (five to seven years on average, encompassing, at the very least, a 20% move up and down). Why take this circuitous route if you could just buy the benchmark and, in effect, stick to the musical score? Risk is the primary reason. The strategies seek to get the same return or better than the asset benchmarks over an entire market cycle. But they are designed to do so while incurring less risk along the way. *** I’m fortunate. I’ve always loved both symphonies and jazz performances. I’d hate to not have either one in my life. Strangely, most investors seem to stick only with the “symphony”—the portfolio of asset classes . They are missing out on all that jazz—the collaborative portfolios of unique strategies that, when blended, seek lower risk and higher risk-adjusted returns in an entire market cycle.