Executive Summary
For much of the past decade or two, one of the most important qualifications for a "good" mutual fund manager was that he/she keep the fund squarely within the constraints of its Morningstar style box, while hopefully generating some positive alpha. Now, however, an emerging group of managers are overtly bucking the trend, with a new approach of "free range" investing.
The "free range" investing term appears to be derived from a news release earlier this year for the FPA Crescent Fund (where FPA is First Pacific Advisors Funds, not the Financial Planning Association), where the manager Steve Romick described the fund as a "free range chicken" in its approach. When asked for further description about the term, Romick explained that the fund is "free range" because it doesn't like to be put in a cage (limiting where it can invest), and is "chicken" because it doesn't like to lose money. Romick states that he allows his fund to invest almost anywhere to generate returns and avoid losing money, ranging from domestic equities to foreign equities to high yield bonds to high quality bonds and even to cash.
The "free range" investing term has received a boost in the financial planning world when it was applied as a descriptive term to several of the investment speakers (including Steve Romick himself) at the recent NAPFA Practice Management and Investments conference in a review of the event by industry commentator Bob Veres in the October 2010 issue of his Inside Information newsletter service. As Veres noted, the major buzz of the investment content at the conference was an emerging cadre of financial planners and fund managers who are being far more active in their investment approach than in the past, and in a far more "unconstrained" manner than ever before.
From my perspective, I think "free range" investing is really just another term for a tactical asset allocation approach (although I have to admit, I think I like Romick's "free range chicken" label more!). Tactical asset allocation appears to be a rapidly growing investment trend within and beyond the financial planning world, as I recently wrote about in the June 2010 Trends in Investing Special Report for the Journal of Financial Planning. And I do not believe that tactical asset allocation is just a short-term "fad" - in point of fact, Ken Solow and I predicted that tactical asset allocation would be an emerging investment strategy in a Contributions article to the Journal of Financial Planning almost 5 years ago, when the market was still in its post-2002 bull cycle. As we wrote in the article, when the market is stuck in a longer-term secular bear market cycle, tactical asset allocation (amongst other more active investment strategies) become more effective to both manage risk and generate return. I think it's no coincidence that the last time we saw a series of incredible active investment managers beat the markets handily (e.g., Peter Lynch), it was in the midst of or overlapping the end of the last 1966-1981 secular bear market cycle.
Why does tactical asset allocation work in these types of market cycles? Because extended difficult economic environments often follow excessive bull market run-ups that leave market valuations at lofty extremes; and it takes a long time to work off those extremes. In the meantime, the markets tend to grind "sideways" in a volatile series of short-term bull and bear markets that produce spectacular volatility but little actual progress in the overall price levels of the index. In such environments, buy-and-hold investing earns flat returns and a more tactical, active approach is vital to maintain and achieve financial planning goals (not to mention the viability of a financial planning firm). Similarly, in such environments, remaining constrained to a single Morningstar style box can become very problematic; it's difficult to generate as much positive value if you're "required" to own a style box category that will be dominated by a sideways market trend.
At some point, we will reach the front end of a new multi-decade bull market, and buy-and-hold investing will be back on the table. For the time being, though, it appears that buy and hold is dead again (as Ken Solow notes in his book by the same title), and the investment trend surveys suggest that financial planners are beginning to realize this after nearly a decade of being delivered sub-par returns from the markets. The bad news is that secular bear markets tend to last for much more than just a decade, so some of the pain may not be over yet. The good news is that means there's likely still time shift to a more tactical approach, whether you want to pursue it with one of the increasingly popular mutual funds like the aforementioned FPA Crescent Fund, or a firm that offers separately managed account services to other planners like Solow's Pinnacle Advisory Group.
So what do you think? Is "free range" investing and tactical asset allocation just a fad, or a good idea here to stay (at least for a while)?
Footnote: In the interests of full disclosure, please be aware that your devoted nerd blogger Michael Kitces is, in addition to his writing and speaking activity at Kitces.com, also affiliated with Pinnacle Advisory Group as their Director of Research.
Michael, I love the _free range chicken_ analogy; thanks for passing it on. A tough issue in implementing free range investing is how to avoid too many chickens who in the aggregate appear to be running around with their craniums absent. If you are trying to use multiple external managers in a single portfolio, seems they could all be leaning in the same direction and you could have a much more concentrated and risky portfolio than you intend.