Recent volatility in the
financial markets has some speculating that we “throw out the old rules and
find something different,” that, in effect, we are living through a new
morality which requires a network of new assumptions. The fact that existing correlations are still
working, albeit not with the result we seek, is irrelevant. Some are suggesting we “throw the baby out
with the bathwater” and start remodeling our risk strategies.
The market’s lack of traction
has, indeed, brought into question many of our fundamental underlying
assumptions about economic forecasting.
Whether by asset class, sector allocation, or capitalization all
financial instruments fell precipitously during the last two years. Safe havens are no longer safe places to be. Credit rating and quality are no longer to be
trusted.
And that, my friends, is the
essence of our near-panic search for new answers: whom, or what, do you trust?
It has become apparent that
“reliable” sources were not. As a
result, valuations became impractical.
But the key to portfolio
structure is to acknowledge in advance
that our data are not infallible and to prepare for that event, or sequence of
events, which might precipitate a market capitulation like the kind we are now
experiencing. Applying those safeguards
is, after all, the mantra of asset allocation.
To wit: “asset allocation plays a greater
role in the probability of portfolio capital gains than does any individual
security within that portfolio.”
Sound familiar? To my clients and protégés it has become
regurgitation.
Innovation.
If asset allocation is key,
then why does the market, or your portfolio, still go down? Most importantly, asset allocation is a
modification, based upon each investor’s risk tolerance, of standardized
data. For some, risk is acceptable. For others, their time horizons or tolerance
for market fluctuation is paramount.
There will always be market volatility. Our goal is to mitigate the impact of that
volatility upon each person’s individual response to that “normalcy.”
Some have gotten hurt by real
estate price declines. Others by the
bond market and global credit crisis. No
one is immune from upside/downside price fluctuations. How we manage its impact upon our finances,
lives, psyches is the ultimate arbiter of today’s financial concerns.
Fundamentals.
Portfolio asset allocation is
also a dynamic exercise. Strategies and
results are constantly in flux, never static, and require constant
adjustment. My clients may recognize,
for example, that during the past 3 decades we have changed our allocations
(macro and micro) continuously to adjust for sector opportunity, regional
opportunity, or perceived risk.
There is no need to modify our
tools at this time, but, rather, to change our mindset about putting square
pegs in round holes. Global markets are evolving. We must adjust our expectations to the
changing times.
The real risk would be to
abandon ship while still on the journey.
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