Why Cullen Roche believes in this new way to build investment portfolios

Cullen Roche doesn’t fit in a box. He’s a California, US-based financial planner and fund manager, but his approach to both aspects of wealth creation are unorthodox. Founder of the Pragmatic Capitalism blog, Cullen runs money via his Discipline Funds business. But overarching all of this is his unusual take on wealth. This is perhaps best illustrated by one of his most recent Twitter posts (he’s prolific on the platform, with more than 85,000 followers).

Cullen’s been mourning the death of his beloved dog, a brown and white Australian shepherd (the breed name is actually a misnomer, having been developed in California in the 1800s but influenced by our Border Collie breed). In a tear-jerking post titled “I am not a dog person any more” he reflects on his first encounter with Australian shepherds. While on holiday in Munich, Germany with his wife around a decade earlier, they encountered a flock of sheep wandering on the road. A wily shepherd dog bounded onto the scene and quickly herded the sheep, leaving Cullen gobsmacked.

Years later, not long after the GFC, he and his young family wanted a dog, and they were stunned to find an Australian shepherd puppy. “It was the best $200 I ever spent and it’s not even close,” wrote Cullen.

But when the dog died “peacefully and beautifully” in early March, he reflected on what money’s really all about: “it’s just a tool for life and loving money is like loving the theatre ticket while you sleep through the performance. Don’t sleep through the performance because it always ends and when it does you can’t get it back.”

This philosophy underpins Cullen’s approach to managing people’s money.

“I like to think it blends a lot of different viewpoints from the world of asset management. It’s a little bit behavioural finance, a bit efficient markets, and a little bit of both asset-liability matching perspectives blended with more traditional finance and risk optimisation,” he says, speaking to me from his office in California, US.

Turning asset allocation on its head

Rewinding a few years, Cullen’s started out by providing more vanilla financial services, when he worked for one of the global industry’s best-known companies, Merrill Lynch.

“We were doing really old-school financial advisory work. But the thing that always really intrigued me about finance was the portfolio management and investment side,” he says.

“I’m not a quant or a CFA, but I’m more analytical in the way I assess portfolios and the operational realities of how things work. So, I ended up developing more of a portfolio management business over time”

Cullen believes the traditional approach to building risk-adjusted portfolios – such as the traditional 60-40 model – is in many ways unsuitable, especially to many of the retired clients he’s worked with over the years.

Cullen describes a traditional portfolio as one that tries to shoehorn together a wide array of uncorrelated assets.

“In summation, it looks very clean and might generate what we call this ‘optimised risk-adjusted return,’ but it may not meet the person’s financial goals in providing enough liquidity or enough insurance (stability) over time,” he says.

“These people are very sensitive to their cash flow needs. And I’ve realised that many of these portfolio structures create a conflict of interest in the way people try to navigate things.”

His growing realisation of these unmet needs is what drove Cullen to develop his All Duration strategy. This flips the traditional portfolio construction process used by pension funds and institutional managers on its head by first quantifying the liabilities of the client and then engineering the portfolio from there.

“We build the portfolio backwards, quantifying what your cash flow needs are over six, 12, 18 or 24 months – or maybe even over multi-year periods,” he says.

Why macro really matters

An understanding of the macroeconomic environment is critically important for investors but is often overlooked in rising markets. Cullen reflected on this in his book, Pragmatic Capitalism: What every investor needs to know about money and finance.

When he published the book in 2014, the GFC was still fresh in his mind.

“Back then, if you didn’t understand what the Federal Reserve or other central banks were doing, you really didn’t understand anything about what was going on. Because they’re driving a lot of the price action in markets,” Cullen says.

He observes that since then, between 2015 and 2020, microeconomics looked much more important. We were all obsessed with the individual companies that were outperforming.

“But then when you have a big macro event like COVID, a big economic downturn and a big policy response by central banks and governments, the macro becomes much more important again.

“And if you were navigating the markets between 2020 and now and didn’t understand what governments were doing in response to COVID, you didn’t have a very good grasp on anything that was going on.”

Housing, mortgages and the economy

It’s not just Australians who are obsessed with real estate – it’s a national pastime in the US, too. There are some key differences in the way the mortgage markets operate in the two nations – 30-year fixed-rate mortgages are the norm in the US while in Australia, fixed rates usually revert to variable rates after between two and five years.

“But the drivers are still really similar. Central banks are all in a bind with inflation high and in response, trying to bring down demand,” Cullen says.

“And the primary conduit for that is the housing market because they’re increasing mortgage rates to make housing less affordable.”

He refers to the slow-moving nature of monetary policy and central banking, which are acknowledged as operating with long and variable lags.

“My theory is that those long and variable lags are primarily the result of the way monetary policy works through the housing market, which is inherently a very slow-moving industry,” Cullen says.

“The real estate market doesn’t change with the same pace as say, the tech sector, where firms can make big changes in a very dramatic manner.”

He alludes here to the illiquidity of property, fuelled also by the bureaucracy and regulatory red tape built into the industry.

Crashes are (usually) quick, booms are slow

This leads to another interesting point Cullen makes about the current macro environment and the ongoing debate about which economies will enter a recession and the likely severity of the downturn.

“The average economic expansion, at least in the US, is seven to 10 years, whereas the average downturn is really only 12 to 24 months. Recessions tend to be much more consolidated events relative to economic booms,” Cullen says.

“But a housing downturn is different because…it’s a much slower, more grinding process. That’s the situation we find ourselves in now.”

He points to the slowing of housing prices in the US, and suspects this process won’t end until 2024 or even 2025.

“It’s a slow, grinding period where we might not even see a technical recession but it will feel like a downturn, something like the early 2000s when we didn’t have a painful, acute recession but a slow grind sideways and lower in many sectors of the economy,” Cullen says.

“It feels like a very sluggish, slow economy…it’s something that’s just going to take time to digest.”