Capital Appreciation Or Preservation?

January 19, 2016

Michael McClary, chief investment officer, ValMark Advisers, Akron, Ohio:

For highly tactical investment strategies focused on short-term market timing, I think the capital preservation versus capital appreciation question is a very viable one right now.

We’re encountering numerous head winds to growth in the U.S. economy, and equity valuations are such they may not provide a significant cushion for stock prices. The global economy is facing head winds as well.

However, we would caution investors to be careful not to become a speculator in the heat of the moment. For our portfolios that manage risk by systematically increasing or decreasing exposure to stocks over time, we use a highly sophisticated strategy that is not predicated on emotion or short-term human speculation.

For typical investors, and even institutions, I often break the investment decision down to "playing ball" or "not playing ball." If they decide they don't want to play ball, then cashlike investments is the place to be. If they do want to play ball in the long term, we believe it’s difficult to try and time the market, and it might be risky not to be invested.

If investors are going to play ball, what’s the best way to do it? That’s where I would say a globally diversified portfolio is relatively well-positioned for the long-term investor. I wouldn’t want to put all of my chips on U.S. stocks right now, given valuation levels, the value of the U.S. dollar and economic momentum. I wouldn't want to put all of my bond money in the aggregate bond index, given interest rate expectations.

Wesley Gray, CEO/CIO, Alpha Architect, Broomall, Pennsylvania:

As a general rule, making decisions during chaotic periods is generally a bad idea. Instead, it’s best to follow a program developed during a calm time that was put in place when emotions weren't as high.

When it comes to capital preservation, there are two things one should have been doing all along:

  1. Holding a globally diversified portfolio (with diversification reducing portfolio volatility); and/or
  2. Applying basic long-term trend-following risk management rules, which manages the risk of very large drawdowns

I don't think the current market environment—or any market environment—implies a need for additional activity or changes. Just because our gut screams “do something!” doesn’t mean we should follow this urge. When in doubt, do nothing. Diversification benefits are straightforward and should be exploited by investors, but 2008 highlighted that diversification isn't a silver bullet.

Trend following is more controversial—and doesn't work all the time—but here is a 200-year backtest highlighting the historical evidence for how trend following can be an effective drawdown management tool.

Andrew Gogerty, vice president, investment strategies, Newfound Research, Boston:

I think people need to be conscious of capital preservation in all environments.

In a sideways market where capital appreciation is nonexistent, income may be the only source of capital growth, which is where having a plan to invest in both traditional and alternative income asset classes can have a great benefit.


Contact Cinthia Murphy at [email protected].

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