Adjust Your Sails

By Randall Coleman, Portfolio Manager, CFA

The last time I wrote about sports and investing was five years and 31 double centuries ago (Stamina: Parallels in Investing and Cycling, 9/16/2019). The gist of that piece was that investing and long-distance cycling are grueling, long-term endeavors. Amongst other physical and mental attributes, they both require stamina to ride out the finish. My sailing experience over the weekend provides a fresh sports analogy and a perfect opportunity to add to the “Parallels in Investing” theme.

Sailing and investing are all about preparedness, knowledge, skill, and adapting to changing conditions. Sailors have weather reports, tide charts, and their own skill to plan and execute their journeys. Investors, similarly, have company financial filings, analyst reports, economic predictions, and a barrage of television and media to “help” them. Forecasters try their best, but we all know forecasts frequently don’t end up panning out. The forecast for my day on San Francisco Bay was 12-15 knot winds: strong and fun, but not too much. What we got that day was a complete gamut of conditions, from dead calm drifting to howling 25 knot gusts to confounding vortex swirls. Each situation has a remarkable and clearly identifiable parallel to investing.

Leaving the marina under sail is often possible, but not advisable. I use the engine to motor out of the marina and to point into the wind in order to get the sails up. The engine is the “auxiliary power.” Sometimes, investors need auxiliary power, too, in addition to traditional equities and bonds. Certain hedging (risk mitigation) strategies require the use of derivatives—put and call options. My engine will now be known as the boat’s “hedging strategy.” The hedging strategy also kicks in when we go under the SF Bay Bridge northbound as there is a significant wind shadow from the skyscrapers in the financial district. The hedging strategy is unwound (engine turned off) as we get close to Pier 27 where the wind is usually strong and constant. Similarly, investors unwind hedging strategies when their goal is attained or their options expire. Investors love the idea of crystal balls. Everybody wants to know the future. Sailors do too, and, arguably, they have a better record of correct predictions. Tides and currents run on a twice-daily schedule, dictated by the moon’s revolutions around the earth. Tide and current predictions are available to all mariners: they are significant factors in planning a voyage, but are well known years in advance. Investors have a very dependable flow of information from the Federal Reserve, the BLS, company financial reporting, etc. The schedule of events is known in advance, but investors often get surprises in their data. Boaters get more surprises from their weather reports than from tide and current predictions.

A glance at the blue line in the chart above shows the week’s wind speed predictions for the Bay (measured at Alcatraz). The repeating pattern is obvious as warm inland air rises and draws in cool ocean air on a regular basis, peaking between 4:00 and 5:00pm every day. The Bay can be both incredibly predictable and incredibly fickle, often both in the same day. Likewise, most of the time, analysts come close, or at least in the ballpark, to company financial results. When surprises happen, stocks make dramatic moves as the market adjusts prices either up or down to reflect the reported data. Sailors also have to make adjustments when conditions don’t match expectations.

Our sailing trip met with unexpected conditions. It was a LOT windier than advertised.

Heading into the wind with full sails in heavy wind can result in “weather helm,” a situation where the bow of the boat tends to turn into the wind. The cause is an imbalance between the forces acting on the sails and the lateral force on the keel. An overly concentrated portfolio, while outperforming during phases when it is in tune with the market, can quickly lose its advantage when market sentiment changes. The dot-com bubble in the early 2000s and the recent/current mega-cap “Magnificent Seven” phenomenon provide real life examples. The overpowered boat has too much sail area and reduced ability to control and steer it. The solution is to reduce power by reducing sail area. “Reefing,” as it is known, allows a “rebalancing” of wind and water forces, enabling the boat to continue on despite the higher wind speed. Likewise, portfolio rebalancing keeps an investor on the right track and can avoid overly concentrated, higher risk positions.

When the boat is balanced and heading into the wind, there is no need to steer. The investing parallel here would be a nicely diversified portfolio in a mild growth environment, steady interest rates, muted volatility and low political intrigue. As you can imagine, this environment is wonderful while it lasts, but it doesn’t last long. When I’m in the Bay, these beautiful runs typically end when I have to turn to avoid an island or a freighter. Regardless, they’re wonderful stretches. Investors enjoy those stretches, too.

At the end of our sail, I had a very difficult time starting the engine due to some undiagnosed electrical problem. Conditions made sailing into the slip impossible as heading directly into the wind is the “no go” zone for a sailboat. Calling for a tow is the least desirable outcome because getting back to the slip under your own power is the highest level of seamanship. The US government towed General Motors and Chrysler with its $17 billion auto industry bailout in 2008. In sailing, it’s all about problem solving—sailors get kudos when they solve their own problems and complete a voyage unassisted. Occasionally, every contingency plan fails and a tow is required. Fortunately for me, a little extra fiddling below deck got the engine started and we completed the sail without a bailout.

Like investing, sailing is challenging and exciting, sometimes dull and boring. You never know what you’re going to get. There are countless perils, yet with diligence, experience, preparedness and skill, sailors and investors can complete the voyage. You can’t change the wind, but you can adjust your sails.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.