How investment managers are preparing portfolios for normal markets, bear markets and catastrophic crashes
Madison, NJ – June 9, 2011 – With investors still wary about the markets and the economy, many are wondering about how to risk-manage their portfolios against sudden declines or protracted bear markets. In light of these concerns, portfolios should include several layers of risk management, each designed to address – and mitigate – different aspects of risk arising from different market scenarios, says Jerry A. Miccolis, chief investment officer, principal, and senior financial advisor at Brinton Eaton, a wealth advisory firm based in New Jersey.
According to Miccolis, investors should ask their advisors about designing portfolios that incorporate the following strategies, to protect them during normal markets, protracted bear markets, and markets experiencing catastrophic crashes:
- Proactive asset allocation and rebalancing that determine appropriate market segment allocations in various economic environments, and rigorous rules to help you adhere to those allocations as markets move within each environment. In normal markets, this strategy helps mitigate losses resulting from volatility — and actually exploits this volatility — by imposing a systematic “buy-low, sell-high” discipline.
- Dynamic momentum strategies designed to quickly identify trends in market segments, providing “sell” signals early during declines and “buy” signals early during advances. In bear markets, these strategies help avoid significant exposure to lengthy declines in specific sectors and the overall markets.
- “Safety-net” protection that applies only in the event of a catastrophic market decline, and costs next to nothing to hold. In “crash” markets, this strategy benefits from the spikes in volatility that typically accompany such declines, while not creating a drag on portfolio performance during more normal market environments. But be careful — most of what’s available in the market, such as puts and collars, are not worth the cost.
Not all risk management strategies are created equal. “There are many products on the market that offer risk protection, but many are limited in the benefits that they provide,” says Miccolis. “For example, the so-called black swan funds may protect against severe market declines, but these investments can have a significant adverse effect on a portfolio during normal, and vastly more likely, market environments.”
And the problem with traditional hedges such as puts and collars is that, while they provide protection, they give up too much in return, he adds. For example, put options are expensive and, once the market recovers, they lose value. Collars, on the other hand, defray direct costs by giving up some potential future gains – not exactly what you want to do after a market downturn.
A single, cohesive approach to risk management – one that provides coverage over a wide variety of market scenarios – provides the best opportunity to control losses and achieve market-beating returns. So, simply balancing risk and return may not be the primary consideration in building a portfolio. It may be finding an investment advisor who can expertly manage — and exploit — risk across a wide variety of changing market conditions.
About Brinton Eaton
Based in Madison, NJ, Brinton Eaton is an advisory firm with a long history of serving 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, retirees, and multi-generational families. For more information, visit www.brintoneaton.com.
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