Dickson On The Best Portfolio Insurance

December 30, 2013

Dickson (cont'd.): The analogy I would make is that you have fire insurance for your house. That’s a black swan event, and pretty much everyone has fire insurance. We all know it’s not worth it, but the question is, Do you still have it, even though the probability of a fire occurring and you needing it is very small?

Investors have to decide that for themselves. I understand the want for it, but you can do it more cheaply, more effectively and more consistently in the form of a high-grade, fixed-income portion of your overall portfolio.

IU.com: Are ETFs the best vehicles to accomplish that, or not necessarily?

Dickson: You can do it any way you want. ETFs are just a delivery mechanism for an investment approach.

IU.com: Why are we talking about black swan events now? Aren’t the U.S. and the global economy on the mend?

Dickson: Well, there’s always tail risk, and we can talk about insulating portfolios from bad events. The main message here is that you don’t have to be all that complicated in terms of the implementation of this portfolio insurance, because the best way to insulate portfolios from unforeseen risk events that could hurt broad equity and other risky asset returns is with high-grade sovereign debt; it’s that simple.

IU.com: As we head into the new year, most seem to expect something to start happening to interest rates. How should investors position their fixed-income allocations at this point?

Dickson: From a Vanguard perspective, we very much say that the market has already priced in what the general expectations are, whether it’s fixed income or equities, meaning that any bets you make relative to the market, or to fixed income, is a bet on your personal view versus the market’s current information consensus.

Because the fixed-income market already has priced in rising rates, over the course of the next several years, that doesn’t mean you could make money by shortening duration necessarily just because you expect rates to go up. The market has already priced that in, in the form of a very steep yield curve where you give up the income component.

That’s to say that in terms of total return, a broadly diversified fixed-income portfolio remains appropriate, like a Barclays Aggregate aproach to the U.S. investment-grade marketplace.

In the end, that fixed-income allocation maintains its role in the portfolio as a diversifier for the equity-centric portfolios most investors have. That’s one of our ways of saying “stay the course.”

 

 

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