Chapter 11

Investing in U.S. and Non-U.S. Equities

In investing money, the amount of interest you want should depend on whether you want to eat well or sleep well.

—J. Kenfield Morley

Once their portfolios have been properly designed, many investors (and, alas, many advisors) immediately move on to the selection of money managers. This is almost always a mistake, because it confounds two allied but distinct issues. Evaluating and selecting managers is one of these issues, of course (see Chapter 17). But a preliminary issue exists; namely, what are the optimal strategies that should be pursued in the asset classes that are to be included in the portfolio? Once asset class strategies have been identified, the manager selection process will be much simplified.

In this and the next few chapters I will discuss best practices for investing in the main asset classes wealthy families employ in their portfolios: domestic equities, non-U.S. equities, fixed income, hedge funds, private equity, and real assets.

Every type of investment asset comes fully accessorized with its own investment challenges, as well as different tax, risk, return, correlation, and other characteristics. And every investor comes fully accessorized with his or her own individual objectives, time horizons, tax issues, and judgments about alpha versus risk premium.

Before families turn their attention to the hiring of money managers, they need to give careful consideration to the characteristics of the asset classes they propose to use and to their own specific needs and points of view. They can then structure investment strategies that maximize advantages and minimize disadvantages. Strategies that might be appropriate for nontaxable investors, for example, might be wholly inappropriate for taxable investors. Strategies that are appropriate for the U.S. large-cap sector might be inappropriate for the international sector, and so on. Once these strategies are in place for each asset class the family plans to include in their portfolio (based on the asset allocation strategy they have selected), the strategies will themselves point us toward a very small subset of the huge money manager population that is likely to be of interest.

Let's now take a look at strategies that are likely to prove productive for taxable investors in each of the main traditional asset categories: U.S. large- and mid-cap stocks, U.S. small-cap stocks, international stocks (including international small-cap and emerging markets), and fixed income.