Investing Based On Long-Term Averages
For the past 50 years, most advisors have relied on how a particular mix of assets perform over the long haul when making investment decisions. The average “moderate” portfolio is typically a 60/40% mix between stocks and bonds. Regardless of whether markets are underpriced, fairly priced, or overpriced, the portfolio doesn’t vary much. This has typically been supported with the explanation that it’s impossible to know where markets are headed. It was believed “staying the course”, according to the asset allocation model dictated by a client’s risk tolerance, established predictability of returns over the long run. This may have been true in the 1950s when mathematical models could not adequately assess the risks in the market.
Evolution To Dynamic Investment Management Based On Risk
In the past decade or so there has been an evolution of these models with improved math and computer modeling. Many of the original people involved in the establishment of “Model Portfolio Theory” in the 1950’s, now endorse risk-based modeling as a superior way to manage assets. The key here is to outperform a relevant index over a market cycle, and not try to chase the “in vogue” asset class.
The significant surge in the U.S. stock market last year was a good example. We believe the financial markets have been making a very slow, gradual recovery, but that it was largely the continued stimulus by the FED that was responsible for these gains.
When managing according to long term averages, the 60/40 stock/bond allocation is maintained, even as the markets were in the “nose bleed” section. This meant that moderate investors, who might be in or near retirement, were taking on undue risk in their portfolios at a time when it would have been more appropriate to reduce risk
In the final months of 2013, Smart Portfolios significantly reduced exposure to bonds, since there was a clear-cut direction of interest rate movements, and maintaining high allocations to this asset class didn’t make sense. As risks increased in the stock sectors, they also reduced exposure, and have built higher than average positions in cash as risks have increased. Newer, Nobel Prize winning models have allowed Smart Portfolios, and others, to make investment decisions in a way that assesses and responds to changes in risk.
We are happy to bring such leading edge decision making to the management of your portfolios. We are confident that decisions made dynamically based on risk will give us the best chance of obtaining solid performance, with much less risk than if we continued to make investment decisions according to long term averages.