The TSC Streetside Chat: Harold Evensky and Robert Markman Debate Diversification

Whoever said opposites attract didn't have Robert Markman and Harold Evensky in mind. These two heavyweights of the financial advice business disagree about almost everything in their profession. Evensky, whose firm Evensky, Brown & Katz manages $360 million, is a fan of traditional diversification and asset allocation. Markman of Minneapolis's Markman Capital Management, with $700 million under management, advocates high-octane growth investing with a technology bent.

Evensky believes investors need a wide range of investment options spread over sectors, market capitalizations and countries. He's expecting a technology meltdown and shapes portfolios that will ease the pain if that happens. To this bow-tie-wearing planner, a mix of growth and value are key.

Diversification is fine, says the frenetic Markman, as long as you stick to high-growth areas. He wants to see investors in technology-heavy portfolios full of stocks of U.S.-based companies. In fact, he's toying with creating technology-only portfolios, achieving diversification through different subsectors.

At TSC's behest, the two debated their investment philosophies, with TSC Staff Reporter Ilana Polyak sitting in as moderator. Here's an edited transcript:

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TSC: You two disagree about the role of diversification in a portfolio, so why don't we talk about that?

Harold Evensky: There always has been an obvious area to invest in for the future: It has been Japan, it's been gold, it's been the auto companies -- it could be most anything for a period of time. So there's no end of the historical gurus who have seen the future with clarity. We believe that you indeed can get higher risk-adjusted returns through diversifying the portfolio.

"I don't disagree that it is a new economy. I do disagree that economics and psychology have taken on a whole new meaning . . . and that the world is totally different." -- Harold Evensky Evensky, Brown & Katz Coral Gables, Fla.

Robert Markman: Where we part is in the concept of volatility being equated with risk. In order to reduce short-term volatility, i.e. short-term risk, we impose constraints upon the long-term growth of a portfolio. Now for somebody who has short-term considerations, I think short-term volatility can be important. But if somebody is investing for a child's college education or their retirement, where they have time horizons that go five, 10, 15 years out, if not longer, the idea of structuring a portfolio so that the volatility over the next couple of quarters would theoretically be dampened, that seems to be a little contradictory.

Investor Panic and Bear Markets

Harold Evensky: One of the things that Bob said we certainly agree with is the concept of risk and volatility and time frame. We've got it in our firm, we call it our five-year mantra, meaning we don't recommend any equity investments unless the client has a five-year horizon.

Robert Markman: My experience with individual investors is that they only tend to panic or get concerned if it's an investment that they either don't understand or don't have confidence in. However, in the past couple of years when we have had our clients in large-cap U.S. stocks with a heavy emphasis on technology, those things, which as you know have been tremendously volatile, have dropped significantly and we've received little or no phone calls on it.

	"You can't say we have a new economy and then say things are not different than they had been before." -- Robert Markman Markman Capital Management Minneapolis

Harold Evensky: And I would agree that in recent history, my clients, as your clients, have not panicked. I don't think there has been panic, and I don't think there will be panic, until and unless we get an extended bear market. Then I think there will be pure panic because people will be saying, "I don't understand, isn't it supposed to come back up?"

Robert Markman: But in an extended bear market, will the more broadly structured portfolios save them in any case?

Harold Evensky: I think it will save them relative to a concentrated large-cap-heavy technology portfolio, absolutely.

Robert Markman: Well, you're assuming the extended bear market is one that hits technology harder than value stocks or real estate.

Harold Evensky: You're absolutely right.

Robert Markman: What would you base that assumption on? Why, in an extended bear market, would you assume that Intel (INTC:Nasdaq - news - boards) and Cisco (CSCO:Nasdaq - news - boards) would necessarily do worse over that time than other groups of stocks?

Harold Evensky: When you've got something at a price-to-earnings or price-to-book in the single or very low double digits, as compared with something in the high double or triple digits, there's just a whole lot more downside to that. If you have a bear market, projecting expected earnings, you just don't get those kind of price-to-earnings ratios. So just the mathematics of the valuation of these is totally out of whack in any market except one that's going straight up. I don't disagree that it is a new economy. I do disagree that economics and psychology have taken on a whole new meaning.

Robert Markman: If you do agree that, yes, it is a new economy, then you have to conclude that we might evaluate companies in a slightly different way.

Harold Evensky: To me, the new dynamics is you lose money and make it up in volume. And I still don't believe that. I don't think it worked before, and I don't think it will work in the future.

Robert Markman: Well how do you figure out the price-to-book on a software company, Harold?

Harold Evensky: Don't use the price-to-book. Use, 'Does it ever make any money? Is it ever likely to make money unless it owns the whole world?' Some of these companies, in order to be successful, ultimately will have to own all of Europe and most of Asia and two-thirds of the U.S. and continue to grow at a rate that means they'll have to start picking up the moon and Mars in the near future.

Robert Markman: I think you and I could sit down with a list of 100 technology stocks and very easily identify those that have to own the known universe in order to justify their P/Es. But if you own all of them as a basket, couldn't you make the case that those that are astronomically valued will fall by the wayside, and the others are going to grow at such a huge multiple rate that it'll more than justify making the investment?

Harold Evensky: Not if the whole basket's overvalued.

Robert Markman: To say that the whole concept is wrong because there are certain individual stocks in that mix that are overvalued, is really, I think, missing what the dynamic is.

Harold Evensky: If you're right, your clients will do extremely well. If you're wrong, they're going to have to work for another half-dozen years, and I just don't have people who want to do that.

Stay Home or Go Global?

TSC: Maybe now would be a good time to bring up international. Bob, could you see maybe changing your stance a little bit on international given the fact that many of these companies are so technology-heavy?

Robert Markman: I don't care that Nokia (NOK:NYSE ADR - news - boards) is a Finnish company. The fact that it's involved in an area that I want to be investing in is important to me. That's why I don't want to invest in labels like Europe or international because it forces my fund manager to fill up a portfolio not only with the good stocks, but also with a bunch of second- and third-rate stocks simply for the sake of being in that geographic area.

That being said, I do think that for the foreseeable future -- and that's all that I can invest for -- the odds are that U.S. companies are likely to be on the cutting edge of the areas that I want to be invested in.

Harold Evensky: I have trouble with what I would consider the myopic concept that the United States will always do better than the rest of the world.

Robert Markman: Nobody said always, Harold. I just said for the foreseeable future.

Harold Evensky: Bob, the one thing I can't argue with is that if anyone can consistently pick for the foreseeable future, the right market to be in, the right stock to be in, or the right country to be in, asset allocation makes absolutely no sense. I'm just suggesting that I don't believe anyone can do it, and if they can do it, I don't know why they're working for a living and would bother to take clients.

Robert Markman: You're setting the bar for a level of precision that is not necessary. I don't believe I have to be exactly right. I remember economist John Maynard Keynes said it's better to be approximately right than precisely wrong.

I don't know the extent to which the U.S. is going to outperform Europe, or the extent to which technology will outperform other sectors. I just know it's unlikely that other things will do significantly better.

Harold Evensky: Well I guess I may be misinterpreting what you say, but I've understood you recently to say you should be primarily invested in large-cap domestic growth with a concentration in technology.

Robert Markman: That's right.

Harold Evensky: That sounds like being precisely right, as opposed to what I believe in, which is diversification, which is not wanting to be ultimately, terribly wrong. To me, it's betting the farm.

Robert Markman: But what you're doing is, you've got a whole list of different asset classes, all of which you're weighting pretty much equally in terms of validity.

Harold Evensky: Wait, who said that?

Robert Markman: : With large-cap U.S. growth --

Harold Evensky: Whoa, stop, stop, stop. I don't know anyone who equally weights when they're doing allocation. I certainly don't.

Robert Markman: No, no, equal weighting in terms of their validity as a potential player in the portfolio.

Harold Evensky: I don't know what that means.

Robert Markman: That means that you've got large-cap growth, and small-cap value, and small-cap value and small-cap growth, and international and emerging markets, and they all are potential players in the portfolio. Whereas if you look at it from the standpoint of contributions to the economy, market capitalizations, large-cap U.S. growth pretty much covers almost every significant area and economic endeavor in our lives.

Harold Evensky: How about non-U.S. stocks? What percent of the world economy does that represent?

Robert Markman: Oh, about, 60%, 65%, 67%, somewhere in that range.

Harold Evensky: Okay. Then why would I leave that out?

Robert Markman: I'm not saying that you should leave international stocks out of a portfolio, I'm just saying you pick the ones that are the good ones.

Harold Evensky: You always pick the good ones.

Robert Markman: If you own a fund like a Marsico Focus, you're going to find stocks like Ericsson (ERICY:Nasdaq ADR - news - boards) or Nokia or any number of good international stocks there. But they're going to be flavoring in the portfolio when they're needed, rather than something that's required to be there simply because of the geographic breakdown.

TSC: Let me ask you, Bob, what percentage of your portfolio is in international?

Robert Markman: Oh, I would guess it's probably in the low single digits. If you dumped all the contents out on the desk of the different funds, it's a handful of stocks.

TSC: And Harold?

Harold Evensky: Probably 25% to 30%. Maybe 25%.

Robert Markman: Nobody, on my end is making the claim that large-cap U.S. growth funds with a tech orientation are going to outperform every quarter or even every year. But for a five-year or longer holding period, it's very difficult for me to come to the conclusion that any of these other asset classes will add significantly to the bottom line of the portfolio.

Harold Evensky: In large-cap growth, including technology, will the United States dominate the rest of the world by a factor of about 10 to 1?

Robert Markman: Who said 10 to 1? Why does it have to be 10 to 1?

Harold Evensky: Well, because if only 8% or 9% of your total portfolio is in international, I'm just using that as a ratio.

Robert Markman: But that doesn't have anything to do with the investment performance. I'm saying that the odds of significant performance are greater here in the U.S., with a greater sense of regularity and security. If European stocks do poorly over the next 12 months, you, I, certainly your clients, have no idea why that's happening, and what the prospects are.

Harold Evensky: As opposed to: We know what's going to happen in the U.S.?

Robert Markman: As opposed to: The environment that we're in, we're willing to at least make an educated guess.

Harold Evensky: Well, I'm not, and I believe I can hire managers who will make an extraordinarily educated guess as to those other countries.

The Value of Value Funds

TSC: Bob, I know you've pretty much given up on value, and your portfolios are growth only. Could you see going back to value as a legitimate investment style?

Robert Markman: Obviously, any rational person likes to buy things at the lowest possible price, so it's hard for me to say I don't like value. The problem I have with value funds as a large group is that their metric makes it very difficult for them to embrace technology. And if I believe that the biggest, broadest economic trend that exists in our lifetime is that of technology, I'm almost forced to move away from value funds.

Harold Evensky: And my problem is, I hear a whopping big bet. A minute ago, you said that even though international may represent 50% to 60% of the global economy, you've got low single digits because you don't want to force a manager to have to do that if they find something better. Now, I hear you saying that you want them to do better, but you want to force them to be in technology.

Robert Markman: But that's not true, I think you're misreading, misinterpreting what I said.

Harold Evensky: I heard you say that you didn't want an international manager.

Robert Markman: Yes, but I don't want to have value, because value won't embrace technology, but that doesn't mean that that's the only area that I'll invest in. One of our largest holdings is White Oak Growth, and as you very well know, Harold, only about 50%, 55% of that portfolio's in technology, and the rest is in financial services and health care. But they still won't take a value approach.

Harold Evensky: I guess when I hear only 55%, that sounds like a pretty major bet to me.

Robert Markman: Well, what do you think is a reasonable allocation of technology now?

Harold Evensky: To be honest, I haven't thought about it, but certainly I would say the 30% to 40% range, depending on the nature of the portfolio, is not unreasonable. I would say 60% is a lot more than we would likely have.

TSC: This seems like a good place for some closing thoughts. Have either of you made any portfolio changes, in, say, the last three months?

Harold Evensky: We made some slight adjustments in our bond durations. We really haven't made any substantive changes I can think about. If anything, we've been buying the things that have been doing poorly, which is what we always do.

TSC: And Bob?

Robert Markman: On the weakness in the last 90 days, we've been adding to our biotech positions, so that not everything that we own was bought at the top. I'll tell you as aggressive as I seem to be, if I really had my druthers, I'd have a very significant position with the portfolio in biotech and let it ride for 10 years, because there's no question in my mind that that's really where the big money's going to be made over the next decade.

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