Following a relatively strong market performance in 2012 and as we approach market highs in the S&P 500, it bears mentioning that we remain in a secular bear market and risks persist. Indeed, bear markets are noted for their ability to take the greatest amount of money from the greatest number of people on both the long and the short side. So while the bears suggest investors take profits as we approach market highs and the bulls are encouraged by market breadth as we climb a wall of worry, we would note that both can be wrong in a secular bear market. And without a clear trend in either direction, we believe risk management remains paramount.
The need for risk management is not lost on clients or advisors. A Cogent Invesco RIA Survey conducted in September 2012 noted that the #1 concern among clients is wealth preservation followed by risk management. Similarly the primary drivers of portfolio construction by advisors were risk management (45%), wealth preservation (24%), beating the benchmark (12%) and absolute return (10%).
There has been a notable softening of the lines in the debate about active management versus passive management since the 20% market decline associated with the European Financial crisis in the summer of 2011. Advisors now recognize that we are more than a decade into the secular bear market and there remains just as much risk and uncertainty as before – a practical solution to risk management is required. Beyond such surveys and our own conversations with advisors, our own Ken Solow (author of Buy & Hold is Dead (AGAIN): The Case for Active Portfolio Management in Dangerous Markets) recently noted the change in sentiment among advisors as well. He spoke at the AICPA PFP conference on a panel discussing Modern Portfolio Theory in January. He is usually targeted by such audiences as a market-timer due to his support for tactical asset allocation. This time the audiences pressed the panel members supporting passive strategies due to their poor performance since the turn of the millennium. A welcome change!
If you are a contrarian, you might conclude that this sentiment shift indicates the secular bear is coming to an end and risks will abate. We would argue the point. First of all because we believe investing is all about risk management in both secular bull markets and secular bear markets – there is a risk of loss in every market. Second, and more currently, the weight of the evidence still suggests caution. The average financial repression lasts 22 years plus or minus 12 years which suggests we may only be half way through the secular bear market. The press reminds us every day that there is no shortage of global risks that still need resolution. A recent GMO report calls this the “Age of Uncertainty”.
Indeed, risk-managed tactical investing will remain relevant for some years to come. Putting aside any uncertainty or volatility associated with these well-known risks, both GMO (The 13th Labor of Hercules: Capital Preservation in the Age of Financial Repression) and Pinnacle (Current Thinking about Secular Bear Markets) are calling for sub-average returns in the future. More to the point, there is risk to investors on both the upside and the downside in a secular bear market. As we noted, secular bear markets seek to take the most money from the most people: bulls and bears alike. While we acknowledge the long list of legitimate market risks that were paraded through the press in 2012, we also observe that equities were strong and volatility was low in 2012. Those who sought to avoid those risks missed the move. That positive momentum continued into 2013 and equities are now approaching their highs. Breadth has been strong, some fiscal issues have been postponed and global central banks continue to prime the pump.
We could well push through the highs. Or perhaps this will be the year when caution pays. Or maybe both. I don’t know the answer. But I have the luxury of relying upon a full-time team of investing professionals with a proven 10-year track record of exceeding the benchmarks with less risk. They monitor the markets in real-time, constantly weighing the evidence to ascertain market risk and adjust the portfolios accordingly. This is not market-timing: in fact our portfolio turnover is quite low at 47%. This is about always managing risk to protect the power of compounding for clients so that they can achieve their financial plans.
Risk management is a necessary but expensive exercise: we spend more than $1 million per annum on people, technology and independent research to produce those results. Most advisors do not have either the time or the resources to effectively risk manage client assets in-house. Fortunately, there are a growing number of money management firms who claim to provide risk-managed investment solutions. Some are good. Some are probably not. Some are comprehensive solutions. Some are partial solutions. Some have long track records based on actual results. Some offer theoretical back-tested results.
Pinnacle offers a risk-managed investment program built by advisors for advisors. In other words, we offer risk-managed investment strategies suitable for one portfolio – one household solution or for the core portfolio role in a core-satellite solution. Our team has generated a 10-year GIPS compliant track record of successfully beating the benchmarks with less risk. We have also designed the program to accommodate some client customization like tax location, legacy assets, and account level withdrawals and cash reserves that most one-size-fits-all money management solutions cannot.
