The Evolution of Our Portfolios in 2016

The summer is a great time to step away from the office and really take a close look at our portfolio process. In the last couple of weeks, I spent about 70 hours reviewing the Relative Strength theory and analyzing how various indicators would have impacted our model portfolios over the last few years.

This summer was especially important: not only have our discretionary portfolios been running for three years, but also we completed a full Relative Strength market cycle in March (we have gone from green, down to red, and back up to green again). It’s instructive to step back and see what has, and what has not, worked over those years. Hypothetical back-testing is very useful, but there is nothing like “live” trading to test one’s convictions about a process when much of the news we see in the media is bleak.

The hallmark of all successful investment strategies is a disciplined and effective risk management process that protects capital in severe market declines. In this Post-2008 market environment, proactive risk management is even more important.

Imagine you are travelling by car across the country. Most of the journey will be spent on long stretches of clear road, but on occasion you will be required to drive through dark tunnels. Visibility is poor in the tunnels and you are not able to see what lies beyond them. 

In some situations, what lies beyond it is a long, smooth stretch of road. In other situations, what awaits you is a sharp turn at the edge of a cliff. Given the unknown, it makes sense to reduce your speed and drive more cautiously.

In January 2016, we received a red signal for the markets.  For us, a red signal is the equivalent of a dark tunnel with limited market visibility. The only other two red signals in the last 10 years were in 2008 and 2011 … not good years for the markets!  In January, we erred on the side of caution and moved $42 million of equities to cash as we said we would. In times like this, we would rather accept the risk of missing out on some of the upside, than take the risk of experiencing a large decline.

This time, the Japanese and European central banks announced new liquidity measures and markets starting bouncing back in a matter of weeks. One has to wonder how much more money central banks can print and how much lower they can take interest rates … but that is a different topic!

There are a number of strange dynamics in the markets that may pose problems in the future (see my June 10th blog post). At some point, the market decline will be much more serious, so we need a process that we believe will help us to change priorities quickly to protect capital. Given what we have learned in the first 6 months of this year, we have added a few new rules/triggers to enhance our current process.

In a way, grappling with the full range of indicators available to us, and finding which ones are the most useful for our portfolios, is like trying to solve a Rubik’s cube. It’s definitely challenging, but we are making exciting progress!

The further we delve into the possibilities of our evolving portfolio strategy, the more confident and the more excited we are about what we can offer to all of our clients going forward. For those who are interested in the details of what we have learned in the last twelve months and how this will shape our portfolio strategy over the coming years, we look forward to our next discussions. For those who don’t want to know the details, rest assured that we are doing all that we can to constantly improve our portfolios and processes while trying to mitigate the volatility as best we can.

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