USAA's John Toohey Talks About Risk, Conviction and Keeping Your Investments Working Smart.
Since joining USAA four months ago, John Toohey has been working closely on asset allocation and product development with Vice President of Equity Investments Ron Sweet, who will retire in July.
A graduate of Williams College with a degree in mathematics, John began his career in New York with MetLife, where he trained as an actuary. Over the next 11 years, he took on increasing responsibility in roles focused largely on product development and asset and liability management in the firm's pension, annuity, tax and investment areas.
He spent the last five years as an investment professional for another large investment management firm, with an emphasis on pension fund management, risk management and client asset allocation.
USAA interviewed John on May 21.
USAA: Asset allocation is your most important job at USAA. How would you describe your philosophy?
John Toohey: First, you can't create superior performance by following the herd, so you can't be afraid of being contrarian and adjusting
your asset allocation when you have a high level of conviction.
Often, that conviction will come from an appreciation of the concept of mean reversion, one of the most powerful forces in financial markets. That idea tells us that financial market variables, including prices, eventually move back towards the long-term average.
Of course, very often when you act on opportunities in the markets, you end up being early, and performance can move against you for a time. That's where patience comes in.
The other key part of my philosophy, which complements what's been happening for some time at USAA, is that we have to have a keener understanding of risk. We must protect investors by constructing portfolios that can achieve desired returns and withstand severe market declines.
USAA: How will this philosophy play out in your asset allocation work?
John Toohey: What we saw last year was that almost all asset classes were highly correlated, as prices for most assets declined simultaneously. In other words, there were very few places to hide. The lesson is that we can't just divide up the asset allocation in the old way between stocks and bonds. We need to think in terms of risk factors and use additional strategies, especially ones that are uncorrelated to stocks and bonds.
There are
risk management techniques that we employ in our asset allocation products that help us to mitigate the impact of huge market moves. Equity index options and certain hedge fund strategies, when used prudently and within limits, are very valuable tools in managing risk. At the end of the day, we need to be very smart with our portfolio construction and tactical asset allocation in order to both capture market opportunities and protect hard-earned assets.
USAA: Do you think that for most members, an asset allocation product is the right solution?
John Toohey: I do. There are some individual investors who do a great job making decisions on their own, but they are few and far between. Too often, people fall into inertia after their initial decision-making, or they chase performance, moving money from the worst-performing asset classes and putting it in the best-performing asset classes. That's the opposite of buying cheap and selling rich, and it can decimate a portfolio. At USAA, our asset allocation process is designed to take advantage of the full range of investment strategies and the insights of experienced professional investors who are solely focused on these strategies every day.
USAA: What is your view of the economy and markets today?
John Toohey: They are two very different issues. In terms of the economy, the U.S. consumer has been the engine of global growth, with much of the spending coming from increased debt on the consumer's balance sheet. With the collapse in consumer wealth, increasing job uncertainty and declines in income, consumers need to save more and they've already begun to do so. The question is, how do we make up the decline in consumer spending in terms of GDP? Usually coming out of a recession you see increased business investment pick up the slack, but that didn't happen in the last recession, and right now many businesses are still worried about survival.
Growth in emerging markets may help exports, especially if the dollar weakens, as we expect it to do, but that's at the margin. I would like to see as much of the government spending as possible — which I must say is necessary but unnerving — go to building productivity enhancements such as infrastructure. Higher productivity is the key to higher wealth. We have to do more than just re-create the debt-fueled, consumer-driven economy of 2006. We know that's not sustainable.
USAA: And the markets?
John Toohey: Markets are all about price. In early March, the S&P 500 was a screaming buy. After the 35% rally, I think stocks are close to fairly valued. Equity prices should reflect future dividend and earnings growth, which are in turn dependent on sales growth and the profit margins on sales. Profit margins were at all time highs back in 2007. They've reverted back to normal in some sectors, so we're really looking at profit margins going forward and expectations for sales.
My concern is that we could be moving into an environment of lower trend economic growth due to lower productivity, deleveraging of consumer and financial balance sheets, increased protectionism, and increased government regulation. At USAA our goal in our asset allocation products is to provide a buffer for our members against any negative impacts associated with these risks.
Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.
posted 7/16/2009