We have written recently about the risks we see in the current market and our concerns over low volatility and investor complacency. This week we are going to follow on with that theme, not because we see doom and gloom around the corner, but rather to further illustrate why we feel that investing to protect your assets is just as important (if not more) as growing them.
To put the chart below (and we apologize for its complexity) into its proper context, the lines represent asset class returns over time. Currently we are in a period that is very rare, in that the 9 major asset classes have produced a positive total return. This is good news for asset owners, however it illustrates that diversification is currently providing little risk management value for investors. While this might sound like an odd statement, remember that the purpose and value of diversification is to provide volatility protection and downside risk management for your capital. If all assets are moving in the same direction at the same time, which is very rare, that risk is elevated. We point this out because almost everyone forgets about risk of loss to their capital when the markets are rising, and once this correlation breaks (as it always does) losses to capital can suddenly await those who are unprepared.
The problem with market declines typically begin when most people ‘feel’ the market is safe and there is a great deal of complacency with respect to volatility and risk. With each major asset class being in a positive total return position, investors see the market as safe. But then again, so is driving a car down an empty road; unfortunately you can’t buy insurance after an accident occurs. Thus we feel that adding some insurance to your portfolio is a smart move when most everyone else thinks it is safe to be “all in” the capital market. Now, we are not calling for an imminent market decline, but a little market softness over the next few months would not surprise us and therefore holding some protection over the summer just in case seems prudent to us.
So what does adding portfolio insurance look like within a longer term growth strategy? The short answer is that it really depends on how defensive you want to be, but we feel that allocating 15 to 20 percent towards defense is a prudent place to start.
For the most part, portfolios would retain many of their current characteristics of fundamentally strong companies that pay dividends, with the addition of elevated cash balances and a higher ownership of gold / gold equities as a starting point. One difference will be whether alternative strategies (i.e. hedge funds) become a part of your portfolio’s insurance. While individual hedge funds are not appropriate for every investor, certain strategies they employ are. Therefore, you can expect us to increasingly discuss strategies that reduce risk, such as market neutral among a few others, as a way to add protection for a portfolio.
For our readers who are sport fans, we have lots on tap this weekend. For Seattle Seahawk fans, the Vince Lombardi Trophy will be at Jack Poole plaza this evening along with several players as the team is in town on a fan appreciation tour. So if you are like me and love football, head down to Jack Poole plaza tonight or check out www.seahawks.com for more details.
Tennis fans will get to cheer on Canadian Eugenie Bouchard in the Women’s Final at Wimbledon. Not sure about Raonic as he was still playing his semi-final match at the time of writing, but congratulations to them both.
World Cup Soccer fans have some fantastic Semifinal matches to watch tomorrow as Argentina takes on Belgium and Costa Rica tangles with the Dutch.
This week marked the end of an era here at Canaccord as our Founder Peter Brown steps away to begin a new chapter in his life. 46 years ago, Peter Brown along with his partners, began what has become Canada’s largest non-bank investment dealer. Peter is a larger-than-life business legend in Vancouver and his daily presence will be missed.
For all those he has worked with and mentored over the years we say thank you.
Have a great weekend.
Thank you for your trust.
As always, we welcome any feedback.
The Dekker Hewett Group