“Fear, greed and hope have destroyed more portfolio value than any recession or depression we have ever been through.” James O’Shaughnessy
As we wait for the upcoming recession just as we might wait for Godot, we will take this opportunity to review principles of long-term strategic investing. As O’Shaughnessy points out, it is the emotionally reactive investor approach that often damages portfolios more than economic cycles (albeit we do believe that depressions may be just as devasting; they just do not occur that frequently).
Refocusing our attention to the long-term view at a time of confusing signals from the economy and major asset classes, is an important step toward reducing the risk to be reactive and deviating from established investing blueprints.
Currently, besides the constant postponement of the inception of the most telegraphed recession in history, we also need to deal with a bond market that gives mixed signals. While we can say that government bonds are rather attractive for the first time in many years, the confusion on the strength of the economy has kept pricing pressure on them. From an equity perspective, while the SP 500 index still shows a strong YTD performance, if we scratch below surface, we must note, again, that a significant amount of the index return is the product of the Magnificent Seven (Apple, Microsoft, Nvidia, Tesla, Meta, Amazon, Google). In fact, if we look at the YTD performance of the equally weighted SP 500, we note a meager 1.26% versus a still respectable 12% from the market cap weighted index version.
So, what is an investor to do in unclear times? Go back to basics and review some major concepts of asset allocation.
Concept 1: how many assets should a portfolio hold? Naturally, it depends on size, investor’s profile, and time horizon, but generally three asset classes (stocks, bonds and real estate) should suffice. For a larger portfolio, an allocation to hedge funds can be very beneficial in lowering overall volatility.
Concept 2: how complex should the implementation be? For many investors, simpler is better. Using ETFs and segmenting moderately by sub asset classes should do the trick of capturing most market returns and lowering costs. Some more sophisticated investors should investigate more complex solutions using options to either hedge risks or capture volatility returns.
Concept 3: should you incorporate commodities into your allocation? Commodities are a tradeable asset which pays no dividend and produces no passive return (beta). However, commodities do provide a strong hedge against inflation. For these reasons, most investors should stay away from direct investments in commodities but could achieve inflation hedging by tactically overweighting equity sectors such as basic materials. Gold is a bit of a different story as it acts as an inflation hedge, systemic hedge and as a global currency.
Concept 4: entry points and valuations. The longer the time horizon, the less relevant is the asset valuation at the entry point. However, being conscious of valuation and adding a moderate tactical approach to your portfolio can be beneficial. Value based tactical rebalances between stocks, bonds and real estate can reduce volatility and hopefully improve long-term returns.
In conclusion, at this juncture, we reiterate the importance of a long-term horizon. We prefer a defensive stance, we favor the utilization of options as risk management tools, and we continue to view bonds as better priced than stocks.
As always, we would like to thank you for the renewed confidence in our work,
Youri Bujko
Davide Accomazzo