This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article is by K. Sean Clark, chief investment officer of Philadelphia-based Clark Capital Management.
After six years of a bull run, and with interest rates set to rise in the future, investors have turned their eyes toward managing the risk in their portfolios. Just as the markets go up and down, so does investors’ appetite for risk. Changes in investor behavior are well-demonstrated by money flows into equities during the late stages of a bull market and out of equities during the late stages of a bear market.
We believe taking a personalized approach to managing risk can help clients remain committed to their financial plan in all market environments. For example, in a low-interest-rate environment, an investor who desires income can add an allocation to a high-yield bond fund such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-64), SPDR Barclays High Yield Bond ETF (JNK | B-68) or SPDR Barclays Short-Term High Yield Bond ETF (SJNK | B-99). The overall investment financial plan does not need to be scrapped entirely.
In this article, we’ll explore the following elements of personalized portfolio management:
- The basics of personalized risk management
- Taking a client-first approach
- Executing a personalized risk management strategy
Personalized Risk Management
As investment advisors, it may be time to take a look at the current bull market and talk to clients about taking some risk off the table. Here are some suggestions for using personalized risk management to help ward off clients’ financial stress:
- Use personal benchmarks to help clients stay focused on their needs, not just market results.
- Focus on the outcomes clients wish to achieve and target investments to those outcomes.
- When appropriate, incorporate downside hedging to protect clients’ downside risk exposure.
A Client-First Approach
We advocate a client-first approach to portfolio construction. Every client is unique, and investments should reflect that. A client-first approach to portfolio management can help clients remain committed to their investment strategies in order to reach their long-term goals.
What we believe makes this approach so compelling is its ability to provide clients with a sense of control over their own destiny. This can prevent emotions from derailing investment plans and can promote successful outcomes.
Executing a Personalized Risk Management Strategy
There are a variety of ways to manage volatility, and each has its pros and cons.
Time can manage volatility, since, over long periods of time, the effects of market spikes are smoothed out. But not every investor has the luxury of a long time horizon, nor do they always have the emotional fortitude to just “stick it out” in a bear market.
If an investor’s time horizon is sufficiently long enough, maintaining focus on a well-diversified, low-expense portfolio may be all the risk management one needs. However, if an investor’s goals call for a more intermediate need for the invested capital, then time alone will not suffice.
Bonds have traditionally been used as a volatility mitigation tool to help provide an income stream and to lower the overall risk of the portfolio. However, the threat of rising interest rates may mean higher volatility in the bond markets. Investors should not expect to receive the same benefits they received over the past 30 years of a declining-rate environment. Rates simply don’t have much lower to go.
The total return of bond portfolios is driven by exposure to interest-rate risk and credit risk. Over the past 30-plus years, investors have benefited by actively taking on interest-rate risk as rates have declined. In that environment, allocating to a core bond portfolio with a heavy focus on interest-rate risk provided a healthy income stream and acted as a good diversifier in a broader asset allocation.