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The stock market has seen an impressive recovery since the end of the last bear market to short life. But as the S & P 500 approaches its historical record (it represents only 5% of end-September 2018 levels), the concern aroused by a further market correction, may be due to the high level of the corporate debt or the weakening of the economy, has not completely put to rest.
Credit: Barclays
Despite all the concerns and uncertainties, it can be difficult for some to decide to stay fully invested or, at least in part, to stay out of the way. Even the experts seem confused. A study of market timers suggests that the recommended exposure to equities has fluctuated strongly, from -72% to December 2018 (nearly three-quarters of its trading portfolio allocated to short selling) to + 73% today (in contrast, a strong uptrend position).
I have a clear opinion on this subject. In my opinion, the moment is more opportune than ever to buy risky assets, provided that they are the "good ones".
Let me explain my point further.
Bullish or bearish, stay invested
Nobody knows what the future holds. Investing by conviction as to what might happen in the markets in months, quarters or even years to come is, in my opinion, pure speculation – remember my article of late 2017 on how which professional forecasters have generally done worse to anticipate the direction of the markets that chance alone would have predicted. Therefore, trying to determine the "right assets" in which to invest today (or even not at all) can prove to be an unsuccessful exercise because the future is unknown.
Addressing his lack of insight into what is hidden around the corner is, in my opinion, an important first step to a successful investment. This concept may seem counterintuitive to those who, despite mounting evidence, still believe that a number of experts can constantly thwart the market. As far as money management is concerned, it may be my most opposite belief:
The best performing investor is not one who can predict the future better than others. Instead, it's the one who knows what he / she does not know, takes full advantage of portfolio diversification and diligently maintains the long-term course.
I now invite the reader to think about the consequences of the phrase "full advantage" above. Diversification is often envisioned in the context of an equity-only portfolio, for example by investing in the 500 names of the S & P 500 Index rather than in a handful of high-conviction stocks. But my investment philosophy is essentially based on the idea that diversification can actually unlock most of its benefits only if it is applied to a multi-asset class investment strategy.
Thinking beyond actions
I've recently written an article supporting the idea that small amounts of gold, maybe even a quarter of the value of a portfolio, can help produce better returns adjusted for the better. risk that an investment in a diversified basket of stocks only. To support my remarks, I introduced the following fun fact:
A portfolio invested at 75% in equities and 25% gold since 1968 would have produced a risk-adjusted performance slightly higher than that of a 100% equity investment: Sharpe ratio of 0.44 vs. 0.42, the worst month of the period reaching -17.5% in April 1980 against -21.7% in November 1987 against the S & P 500.
This may seem counterintuitive, as gold has generated lower annual returns than equities since the late 1960s, while being exposed to higher levels of volatility. What makes the diversified portfolio more attractive from a risk perspective is the very low levels of historical correlation between equities and gold: -0.01 over the last 50 years. It's the effect of Harry Markowitz's free lunch at full speed.
I could go further. Since 1987, another asset class has behaved very independently of equities: US bonds, at a correlation factor of only +0.07. The chart below illustrates how a $ 10,000 portfolio invests 35% in equities, 40% in US bonds and 25% in gold (Portfolio 1, blue line) versus a similar sized portfolio invested in equities only. (wallet 2, red line). from 1987:
Source: Portfolio Visualizer
Some very important observations and conclusions can be drawn from the table and table above.
- First, the more diversified of the two portfolios produced impressive risk-adjusted returns, as evidenced by Sharpe and Sortino's high ratios of 0.63 and 0.95 (compared to the 0.51 and 0.72 all-equity portfolios). ). The strong relative performance indicators of Portfolio 1 were supported by an annual volatility of only 6.8%, about two and a half times that of Portfolio 2.
- Second, investments in multiple asset classes have never entered bearish territory, even during the extremely destructive recession period of 2008-2009. From peak to bottom, Portfolio 1 lost a maximum of 17% of its value in 2008. At the same time, more than half of the market value of Portfolio 2 was erased in less than 18 months, at about the same time.
- Thirdly, it is important to recognize that a well-diversified portfolio with many asset classes that contains less risky fixed income securities (in this case, up to 40% of the total) will probably never perform better than a 100% equity investment. run, in absolute terms. So, in general, broad diversification beyond equities is often seen as a less risky approach for those willing to give up aggressive returns in exchange for a little more peace of mind.
Although, in my opinion, the last point above is generally true, some techniques could still allow long-term, high-growth investors to take full advantage of the benefits of multi-asset class diversification.
An example of a portfolio that can outperform equities
Since early 2017, I have invested (while refining) a portfolio that, in my opinion, could at least follow the S & P 500 in the long run without being exposed to the same level of risk of loss. My general approach is to use leveraged ETFs, even in moderate doses, to build a portfolio that will hopefully be less volatile and less painful. I understand that leverage may be controversial and may scare the less sophisticated investor – perhaps he should, because leveraged instruments are a double-edged sword that may be both useful and dangerous. So, a word of caution here is certainly warranted.
Take the example of Portfolio 1 above: 35% equity, 40% bonds and 25% gold. If I had to replace half of the bond position with a leveraged treasury instrument like Direxion Daily 10-Year Bull Treasure ETF (TYD) (I wrote about this fund in more detail recently), I would actually manage to get a total portfolio leverage factor of 1.4 times:
- 35% in stock, plus
- 20% in non-indebted bonds, plus
- 60% in the form of leveraged bond funds, plus
- 25% gold
Source: DM Martins Research
At these levels, matching the absolute returns of the stock market over time could become a little more plausible, while the risk of portfolio loss should remain less than that of an investment in pure stocks.
Of course, the allowances above could be further adjusted to achieve a better balance between the different classes of assets. For example, I think that an allocation of 80% (out of a maximum of 140%) in bonds and 35% in equities would probably give this portfolio a too conservative profile for most growing investors. In my core portfolio, for example (which I named Storm Resilient Growth, reference to its dual mandate of capital appreciation similar to that of a market and superior protection against the risks of down), I chose to allocate 45% of the total portfolio to equities. .
Note that, in this case, leverage is used for the counterintuitive purpose of reducing the risk of a portfolio or its downside exposure without losing much in terms of growth potential. This is, in my opinion, an example of a case in which leverage could be deployed in a responsible manner. The multi-asset class approach, in which riskier assets (equities, gold) are mixed with significantly less risky assets (high quality bonds, treasury bills), facilitates the use leveraged instruments to create what should, in my opinion, be better balanced, less fragile investment strategy (ie weather-resistant).
Key to take away
I do not know what the future holds. And in my profession as a portfolio strategist and analyst, I regret to see many market players devote valuable time trying to figure out which stocks or asset classes will outperform in the foreseeable future, thinking ( or experts they will follow closely) could hold the hidden key of wealth to which other investors do not have access.
As I mentioned earlier in this article, market professionals have radically and quickly changed their minds about the opportunity to wager on or against the stock market in the first weeks of 2019. Quoting exercise proved unsuccessful while these experts The bearish position probably prevented them, as well as their clients, from missing the strong equity rally early in the year. I hope that lessons have been learned from this experience.
For my part, I continue to agree, that the vast majority of investors will almost always benefit from being fully invested in risky assets. In my opinion, being away from the financial markets is the strategy best suited to those who may have short-term cash commitments – while being short-term risky assets generating a positive return expected, this is the best strategy. Is a game of pool that only players should consider, at their own risk.
As far as I'm concerned, I'm trying to achieve the goal of generating market-like returns with lower risk through multi-asset class diversification, alongside my premium community on resilient growth. to storms on Seeking Alpha. For example, I've used some of the ideas presented in this article to create my flagship SRG Core portfolio, one of four investment strategies currently being followed. To become a member of this community at 2018 prices and further explore the investment opportunities, click here to take advantage of the free 14 day trial period available today.
Disclosure: I am / we are TYD for a long time. I have written this article myself and it expresses my own opinions. I do not receive compensation for this (other than Seeking Alpha). I do not have any business relationship with a company whose actions are mentioned in this article.
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