Lombard Odier: Investing like a Viking: portfolio strategy and navigation lessons

Lombard Odier highlighted that a successful investment strategy, built on strategic allocation, tactical adjustments and prudent instruments, historically outperforms staying in cash.

Global wealth manager Lombard Odier has published its latest Global CIO Viewpoint, The Intelligent Allocator, featuring insights from global chief investment officer, Michael Strobaek, and portfolio manager, Clément Dumur on deploying capital.

To use an historical analogy, for more than three centuries, Scandinavia’s Vikings ventured far beyond their home waters, reaching as far as ‘Vinland’ on the coast of North America. They sailed west not because they could accurately forecast the weather, but because they combined determination with seamanship skills honed over generations. Of course, venturing out of harbour requires the notion of accepting risk. Many investors prefer to linger behind, moored in cash, thinking that avoiding every storm is prudent seamanship. But while they’re on a ship technically, practically their portfolios are going nowhere.

A disciplined investment strategy rests on three pillars:

• Strategic asset allocation (SAA) is the foundational framework – choosing the right vessel to set course to the chosen destination, understanding long- term currents, and so maximising the probability of reaching a far shore. It reflects the realities of the journey: the capacity to take risk, time horizon, liquidity needs, and the tolerance for discomfort when the waves rise higher than forecast. Adjustments are rare and intentional, much like nudging the tiller to correct course rather than spinning the ship’s wheel in the hope of magically avoiding every cloud on the horizon.
• Once the course is set, the tactical asset allocation (TAA) becomes the art of adjusting the sails when conditions shift. It is not an attempt to forecast precise turning points in markets. The TAA is responsive, not predictive. On a voyage, visibility varies, gusts of wind arrive early or late, or currents pull harder than the models assumed. The TAA deals with the world as it is, not as investors wish it would be.
• Instrument selection – for example, the choice of investing passively, actively, in funds or in individual securities – is the rigging that ensures the vessel responds to commands. It does not calm a rough sea, but it ensures that the ship obeys the captain. The question is always the same: does this choice of instruments help investors pursue the course set by the SAA, with occasional refinements from the TAA?

A compass that swings between pessimism and optimism

“In the short run,” said investor Benjamin Graham, “the market is a voting machine; in the long run, it is a weighing machine.” In other words, in the short term markets misprice risk because sentiment dominates, but over time fundamentals reassert themselves. Equally useful is his reminder that markets oscillate between unjustified pessimism and unsustainable optimism. The intelligent investor, Graham wrote, is a realist who buys from pessimists and sells to optimists.

If we focus on the former – buying from pessimists – history shows that the market has repeatedly offered opportunities for patient investors. Since 1995, the S&P 500 has delivered an average annualised total return of 13%, while the average intra-year drawdown was 15%. Swings are not market anomalies but part of the investment journey.

Nor is this pattern new. Nearly six decades ago, Paul Samuelson, a Nobel-prize-winning economist, wrote in a column for Newsweek that “Wall Street indexes predicted nine of the last five recessions.” That statement still looks sound. Since 1945, the S&P 500 index has seen 24 corrections of 15% or more, while the real US economy has experienced only 13 recessions. Investors, simply put, overreact.

These moments can offer opportunities for tactical adjustments. But knowing when – and when not – to move is the difficult part. Let us look at how SAA, TAA, and market-timing instincts play out in practice by considering three simplified investor portfolios:

• Investor 1 adopts a pure SAA strategy – sticking to a balanced SAA of 45% equities (S&P 500) and 55% bonds (Bloomberg US Aggregate)
• Investor 2 embraces SAA and TAA – investing in a balanced SAA but shifting to a growth profile (65% equities, 35% bonds) after a 15% correction – the average over the last 30 years – and then returning to a balanced SAA when the drawdown ends

Investor 3 attempts market timing – staying in three-month cash deposits and allocating 45% to equities only after a 15% correction, returning to cash at the end of the drawdown.

The outcomes are telling. Investor 2 – with a disciplined combination of SAA and TAA – earned an additional +0.5% per year relative to implementing an SAA alone. Investor 3 – the market timer – fared by far the worst, lagging both the SAA portfolio and the combined SAA and TAA by -3.2% and -3.7% respectively. A ‘market timing’ portfolio therefore preserved the psychological comfort of cash but at the cost of meaningfully worse results.

Here we would caution against making sudden, mechanical TAA adjustments in response to events. Market dislocations, especially after sudden shocks, demand analysis not reflexes. A sensible process should consist of three steps: 1) assess the facts, 2) compare them with historical precedents, and 3) build an informed, unemotional judgment. Many investors unfortunately attempt to leap to the last step, snatching at the wheel with an uninformed and emotional response.

TAA complements but does not replace SAA

The SAA remains the primary driver of a portfolio’s long- term returns, and while it is possible to debate the percentage contribution of different assets, the principle is not in question. The SAA blends imperfectly correlated assets to improve risk- adjusted outcomes through discipline, structure and periodic

The TAA’s contribution is inherently tied to taking incremental risks. Portfolio risk cannot be eliminated, only priced, and then adjusted or transformed. No tactical decision will ever produce equity-like returns with bond-like volatility. And while market timing offers the illusion of safety, history shows otherwise: after a 15% correction, market-timing investors have realised drawdowns similar to those of SAA investors, but with far lower returns. The resulting Sharpe ratio - a measure of risk-adjusted returns - is roughly 0.3, half that of a pure SAA strategy.

In summary, the Vikings’ voyages succeeded not through perfect foresight but through a balance of strategic objectives and tactical skill. Investing is not very different. Rather than waiting for perfect weather, the intelligent allocator knows that the rewards of committing capital come through undertaking the voyage: setting a destination with the SAA, adjusting course with informed TAA decisions, and making a prudent selection of investment instruments along the journey.

Re-disseminated by Wealth and Society