Portfolio Navigation History

A new approach to guiding portfolios through storms in financial markets.

A brief history of navigation:
The magnetic compass was first invented by the Chinese in AD1080 but it was not used for navigation until AD 1111. Knowledge of the direction pointing North made it possible to estimate the direction one was heading. That was useful when a ship was leaving the harbor, but useless when one was out of sight of land. Until the 17th century sea captains relied on guesses about the currents, winds and speed to estimate their location. This was called, “dead reckoning”, probably because it often marked the crew for dead if the estimates proved wrong.
Due to coastal fog, many ships missed the harbor entrance to London and ended up on the rocks. This caused the King of England to offer the equivalent of a million dollars to the man who could solve the longitude problem. Everyone knew how to obtain their latitude, so knowing the longitude would fix their location where the two lines crossed. In 1736 an unknown amateur watch maker created a watch that solved the problem. Unfortunately, he lacked any formal training in watch making as well as any academic credentials, so his solution to the problem was blocked by the learned establishment for the rest of his life. The result was, John Harrison died a pauper and many lives were lost unnecessarily.
When I was in the U.S. Air Force, navigation training still began with dead reckoning and every flight plan began with estimates of the winds aloft, the lines of magnetic variation we would cross and our planned airspeed, all of which never proved correct. So the essence of navigation remained the same: determine your current location periodically and plot a new heading to your destination. It would have been unthinkable to “stay the course” in hopes that friendly winds would blow you back on course.
Portfolio navigation:
I believe the basics of navigation apply to portfolio management. If we view the client’s portfolio as a vehicle that needs to be navigated through financial markets, wouldn’t the return needed on the portfolio be akin to the heading the portfolio manager needs to steer in order to reach the planned destination? We call that heading the Desired Target Return® or DTR®. And if financial storms blew the portfolio off course, wouldn’t the ability to plot a new DTR to the desired destination be preferred to “staying the course?

This view challenges the basic assumptions about why people invest and how best to manage those investments. Portfolio Navigation assumes people are trying to get from where they are financially to where they need to be at some specified time in the future. More specifically, they want to reach a financial goal that provides a certain payoff that will achieve the goal. If a 401(k) investor wants to replace 70% of salary at retirement, doesn’t that define the goal and allow a reasonable estimate of where the portfolio needs to be in order to make that payout at retirement? Viewed as a navigation problem, would it make sense to put an investor in one portfolio until retirement and say, “just stay the course and maybe you’ll get there”? Only if one has no knowledge of portfolio navigation.

Just as the compass was the beginning of the science of navigation, Modern Portfolio Theory was the beginning of a new science of portfolio management. Portfolio Navigation provides a way to use the compass, along with the equivalence of longitude and innovations in equipment, to navigate the financial markets of the world and bring the portfolio safely to its desired destination. We hope this will prevent many portfolios from ending up on the rocks.

About Frank Sortino

Frank Sortino is finance professor emeritus from San Francisco State University and Director of the Pension Research Institute which he founded in 1981. For 10 years he wrote a quarterly analysis of mutual funds for Pensions and Investments Magazine and he has written two books on the subject of Post Modern Portfolio Theory. He has been a featured speaker at many conferences in the U.S., Europe, South Africa, and the Pacific Basin. Dr. Sortino received his Ph.D in Finance from the University of Oregon and has carried out research projects with many institutions like Shell Oil, Netherlands and The City and County of San Francisco Retirement System.
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