What If “2008” Happened Again? New Techniques Offer Promise to Minimize Downside.
The holy grail of investing is a portfolio that doesn’t go down when the stock market plummets, but goes fully along for the ride when the market soars.
“There are still no magic bullets, but some new investing strategies are emerging that can help protect a portfolio from major losses and still offer plenty of upside,” says Jerry Miccolis, an authority on asset allocation and Chief Investment Officer at Brinton Eaton, a wealth-management firm in Madison, N.J.
Miccolis says his firm’s research on market crises offers these lessons:
Use alternatives more. Brinton Eaton now invests up to 35 percent of its clients’ assets in “alternative” investments, which include managed futures, market neutral and absolute return strategies, in addition to real estate and commodities. Managed futures generally go up when commodities either have a strong bull market or a strong bear market. Market neutral strategies attempt to provide equity-like returns, but with low correlation to equity markets themselves, which make them great diversifiers. Absolute return strategies attempt to provide positive returns regardless of what the markets are doing.
Diversify your mainstream investments more than ever. Look to small-cap international and emerging market stocks. Also consider investments in timberland, agribusiness, and global infrastructure.
Use new kinds of investment to hedge against extreme drops. The ideal portfolio hedge is one that kicks in when you most need it, but doesn’t represent a drain on your portfolio in normal times. Until recently, nothing did that at a reasonable cost — i.e., without requiring a sizeable capital outlay that would divert too much of your portfolio from productive purposes.
However, a new approach designed by Deutsche Bank, called EMERALD, works by exploiting a phenomenon about the equity market’s behavior. The S&P 500 index moves quite a bit from day to day, but rarely goes in the same direction for very many days in a row. Its movement from week to week is typically less than daily movements would imply. There are usually intra-week reversions — even during market collapses. EMERALD exploits this behavior by betting on this phenomenon each day. In the long run, the strategy wins. But the principal reason Brinton Eaton has EMERALD in client portfolios is its expected behavior when markets go into a tailspin, as they did in the fourth quarter of 2008. In those situations, it is expected that EMERALD would dramatically appreciate, offering close-to-ideal portfolio protection.
The way Brinton Eaton invests in EMERALD is through a custom-designed investment product called a “structured note,” a promissory note issued by Deutsche Bank. The note contains two index components. One is the S&P 500 Stock Index, and the other is EMERALD — you get exposure to the S&P 500, with EMERALD attached to it. The cost built into the note is less than the expected growth in the note beyond whatever the S&P 500 does.
“The protection should pay for itself,” says Miccolis. “It may not, but we believe that chance is small.”
There are some risks associated with this structured note, but Brinton Eaton’s analysis indicates that they are commensurate with the expected benefit.
“The protection is not perfect, but it the best we have seen so far,” says Miccolis. “And, we continue to research products and strategies that will protect our clients when the markets don’t cooperate.”
Brinton Eaton has produced a podcast on this topic. To listen to it, click here.
One of America’s leading authorities on asset allocation, Miccolis, CFA®, CFP®, is a senior financial advisor, Chief Investment Officer, and co-owner of HYPERLINK “http://www.brintoneaton.com” Brinton Eaton, a boutique wealth advisory firm in Madison, N.J., serving individuals and institutions throughout the U.S. He is also author of Asset Allocation For Dummies® (Wiley 2009).
About Brinton Eaton
Based in Madison, NJ, Brinton Eaton is a boutique advisory firm with a long history of serving affluent individuals and their families across multiple generations. The firm helps its clients protect, grow, administer and ultimately transfer their legacy of wealth through a full range of integrated services, including lifetime cash flow projections, financial/tax/estate/retirement planning, investment management, charitable giving, and business succession planning. Brinton Eaton’s clients tend to be corporate executives, professionals, entrepreneurs, and retirees with investable assets over $2 million. For more information, visit www.brintoneaton.com.
