Over the past thirty plus years as an investment professional I have witnessed the slow evolution of how risk has been addressed by the industry. Early in my career as a broker the focus was on selling individual securities and risk was largely a seat of the pants calculation that the client was responsible for, and many times was simply a function of how they felt at the time. Then the crash of 1987 occurred, and suitability became a larger issue. Gradually the adoption of modern portfolio theory and strategic allocation was accomplished in the nineties. Many brokers became advisers, and the focus began to turn toward financial planning with a total reliance on strategic allocation for investment strategy. Adjusting portfolio exposures and risk for client circumstances made perfect sense. The bear markets of 2001-2003 and 2007-2009 demonstrated in a tangible way that correlations between assets were not stable and, in many instances, approached one. So, the financial industry added alternative assets that were supposed to be less correlated to public markets. The pandemic of 2020 has exposed some of these investments, particularly commercial real estate as people left the office to work from home. Strategic allocation has a role but is not a total solution.
It seems to me that a portion of a client’s assets should be dedicated to adjusting portfolio exposures and risk for market circumstances. Firms with large asset bases have a difficult task doing this since they can move markets if they move dramatically so they must rely on larger trends in the economy and markets for their decisions. In many cases factors that they cannot anticipate arise in a short period of time. In 1987 the imbalance created by the portfolio insurance strategy and program trading grew quickly and led to the crash. The bear market of 2001-2003 was exacerbated by 9/11. The subprime credit crisis took down two large well known and respected firms. Then a virus surprised markets in 2020. The advantage in this area rests with smaller firms who can adjust on a nimbler basis. The question becomes what factors should be used to make those decisions.
The answer at Capital Advice is to use the market data itself. The assessment of risk used is based on market internals and price volatility. Elevated changes in internals or volatility indicate that enough market participants are recognizing risk and acting in their portfolios to warrant concern. When this happens a move from long-term signals to short-term signals to make investment decisions is systematically accomplished. A return to long term signals is embedded in the discipline when risk abates and volatility subsides. I hope you would take some time to study the research reports on the site and schedule a time when we can discuss how the signals are generated and how we may work together.
Scott Briney