'Buy & Fold': An Alternative Strategy

Simon Baker, the founder of Baker Avenue Asset Management, got his start managing wealth at big Wall Street firms.

Money in Mattress
Money in Mattress

But the U.K.-born money manager bristles when presented with arguments for the traditional "buy and hold" methodology still touted by his various alma maters.

"I don't want to be coy or anything, but I think people are tired of seeing these same commercials and seeing these same adverts," says Baker. "It's like that expression of putting lipstick on the pig. People are like, 'Wait a second, you can change the quote but it looks exactly the same and tastes exactly the same.'"

With characteristic British drollness, he refers to a marketing campaign by Charles Schwab: "It's not 'Talk to Chuck;' it's 'Chuck Up.'"

Of course, Baker's San Francisco-based firm is also in the business of managing people's money — albeit on a much smaller scale than Chuck, Fidelity or Vanguard, where the "buy and hold" catch phrase originated and flourished. Baker manages $600 million in assets, vs. $1.4 trillion to $3.3 trillion at the titanic buy-side firms.

But unlike its bigger competitors, Baker Avenue managed to earn strong returns throughout the financial crisis and its ensuing volatility, by exiting the stock market when equity prices began to flounder.

In fact, Baker Avenue ranked No. 1 in referrals and assets raised through Fidelity, its custodial partner, in 2009 and so far this year.

Baker Avenue's assets have grown in each year since its founding in 2004 and the firm touts a 53% return over that span, vs. a broader market return of 2%. Simon Baker attributes the performance to his fearless ability to park assets in cash—something unheard of during the boom times, but assuring for investors today.

Baker Avenue held cash for 10 months during the rocky times of 2008, which doesn't sound all that alluring to investors who need to play catch-up on with 401(k)s. Yet the firm says its All Cap Core strategy still managed to capture 104% of the S&P 500's upside for the past five years and just 34% of the downside by getting out ahead of big crashes—including the "flash crash" of May 6.

Baker, who began his career at Morgan Stanley in 1994, and Baker Avenue's Chief Investment Officer King Lip developed a market-sentiment indicator to warn of coming sell-offs over a decade ago. The two honed their skills in the wealth-management divisions of Bank of America and the one-time investment bank Donaldson, Lufkin & Jenrette, which was acquired by Credit Suisse in 2000.

Baker and Lip spoke with TheStreet about their "buy and hold" alternative and how average investors can capture upside the Baker Avenue has in recent years:

No more buy and hold

TheStreet: You're very against the notion of "buy and hold" Why?

Simon Baker: The central premise of "buy and hold" ignores the changes in risk in the market. The economic harm done by blindly riding these downturns now has disastrous effects on individuals.

People are starting to realize when they're working with advisors that this idea of "buy and hold" has been an idea strongly promoted by the industry for a long, long time. When you really kind of ask yourself, Why is it that the brokerage firms and investment management firms don't tell clients to go 100% into cash? It's a little bit of a joke really when you see some of the asset allocations. Abby Cohen at Goldman Sachs comes out and she's recommending to the retail force that you increase your cash allocation from 5% to 7.5%. I mean, that has no impact on the retail investor. I think people are laughing at that now and saying that's silly.

But why don't they do that? Well, brokerage firms and investment management firms don't make any money telling clients to go into cash. I mean, that's the reality. And they're never going to be recommending it. And that's the problem that a lot of these firms are in right now.

Bernstein, for example, is a classic "buy and hold" value investment management firm. But they got killed in 2008, clients are saying, 'Why do you get me fully invested all the time? I need a better strategy.' So now all of a sudden they've come out with a new product where they're taking 20% of clients' assets and saying we're going to put it in some kind of new tactical vehicle where we're going to get it out of down markets. Well, they've got no experience doing that; they've got no track record of doing it. And essentially it's going to be very challenging to do it.

Risk for an institution is very different than a risk for an individual. "Buy and hold" might work for an institution that has long-term strategic goals and can weather the storm. For the person that's in retirement or is trying to get their kids to college that was down 40% or 37% in 2008, they mightn't have time to recover. So a buy-and-hold strategy that makes sense for an institution might clearly not make sense for an individual.

TheStreet: What strategy should investors adopt instead?

King Lip: The way that traditional "buy and hold" investors control risk is through diversification. You keep hearing that: 'You've got to diversify, diversify, diversify.' But then they don't tell you the other side of the story, which is, in down markets - which we experienced in 2008 and 2000-to-2002 - diversification really doesn't help you. In fact, correlations increase in down markets.

The way we see it is that in down markets like that... you really need to take a much more dynamic approach to control risk. You do that by actively raising cash in those types of environments.

TheStreet: It's important to protect against the downside, but then how can investors go about making money?

King Lip: Essentially what we're doing is we're saying we should move to cash now, for now, to preserve the capital for a better time to invest.

Historically, since we've been managing this strategy, the time that we've been in cash on an annual basis is relatively short. Now, 2008 was kind of an unusual situation where we spent about 10 months in cash because of how dire the situation was in the market.

We still believe that equities is really the best place to be, but not the "buy and hold" strategy. A lot of money flows have been going into money markets and bonds, but even in bonds right now we think it's going to be challenging going forward. Interest rates only really have one direction to go. So if rates go up, bond values are going to go down. So we think the bond trade itself is kind of an old trade.

TheStreet: What about gold?

King Lip: We're bullish on gold right now. The reason why we like gold is because it's an insurance policy. And that's how people should look at gold, as an insurance policy.

Investors have insurance policies for their biggest assets. They have insurance policies for their homes, their cars, their boats - why not have an insurance policy for your portfolio? It makes perfect sense to us.

Simon Baker: When we think about risk, it's sort of like a commercial airline that's flying a plane in the middle of a gathering storm and all the indicators predict there's going to be a full-blown hurricane. You've got to keep the plane on the ground. But the industry has sold the idea that the best way to weather the storm is to keep the plane in the air. It just doesn't make any sense at all.

I think retail investors are starting to understand that a little bit, and saying, 'There's got to be a better way than just sort of flying up into the air and hoping the storm goes away.'... This isn't your father's market. This isn't the same type of market that we were in 10 years ago and yet we're still employing the same strategies that we were having 10 years ago.

TheStreet: Can you explain the Baker Avenue Market Sentiment Indicator, or BAMSI, (depicted in chart above) that Baker uses to monitor risk?

King Lip: We have an index of over 4,000 stocks that we measure. When greater than 50% of those stocks are bullish, what that means to us is that it's a friendly environment to invest. It's a low-risk environment. That's what you want to take risk and when you want to be invested in equities.

When greater than 50% of those stocks are bearish, that's a high-risk environment. And as Simon had said earlier, that's a stormy environment. That's when you don't want to fly the plane, that's when you want to keep it on the ground, that's when you essentially want to retain cash and keep it on the sidelines.

TheStreet: So for an average investor who doesn't have this index, what would you suggest for someone who's reading TheStreet.com, looking for ideas on how to invest?

King Lip: There are a lot of things people can use ...The VIX, for example is a good indicator of that. We know that when things start getting really risky in the market, the VIX shoots higher - it inevitably does. If that's the case, that should be a warning sign for investors, that something's wrong out there.

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Disclosure information was not available for Lauren Tara LaCapra or her company.