Abnormal Can Still Be Rational

November 22, 2017

What To Do In Today’s Low-Risk Environment

Hedging against downside risk amounts to taking out insurance on your portfolio, and as we are aware, insurance has a cost: premiums. Those betting on a spike in VIX via VIX futures or ETFs are, in essence, paying insurance premiums in the form of a steep term structure with negative roll-down costs.

For equity investors, some would argue for investing in lower-volatility or higher-quality stocks or ETFs, but these come with their own risks, such as introducing unintended interest-rate volatility or lower long-term expected returns, because higher-quality stocks tend to trade at a premium to the overall market.

The simplest way to reduce downside risk is to reduce your equity ratio, as pedestrian as that might sound. But reassessing one’s equity exposure also helps better frame one’s time horizon with one’s tolerance for taking on market volatility. Otherwise, narrower risk premiums imply lower expected returns for equity and fixed-income investors going forward. Again, this assumes you have the requisite time horizon to ride out the volatility.

Alternatively, one can expand the risk premiums in a portfolio to include liquid alternative risk premiums such as managed futures and long/short baskets, many of which are available in ETFs. However, this requires a more sophisticated skillset, and such strategies aren’t necessarily immune to market volatility. That said, they can potentially diversify the general equity and fixed-income risks in a traditional equity/bond portfolio.

A low-risk environment producing low expected returns for the risk involved is the reality we all face as investors. You can be like Warren Buffett and take your ball and go home, but that would leave you underinvested for the long run. A market correction will eventually come, and it could be at that moment that the strong hands earn the risk premiums from the weak hands.

The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes and opinions of others are assumed to be true and accurate; however, 3D Asset Management does not warrant the accuracy of any of these. There is also no assurance that any of the above is all inclusive or complete. Past performance is no guarantee of future results. None of the services offered by 3D Asset Management are insured by the FDIC, and the reader is reminded that all investments contain risk. The opinions offered above are as of Nov. 20, 2017, and are subject to change as influencing factors change. More detail regarding 3D Asset Management, its products, services, personnel, fees and investment methodologies are available in the firm’s Form ADV Part 2, which is available upon request by calling (860) 291-1998, option 2, or emailing [email protected] or visiting 3D’s website at www.3dadvisor.com.

 

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