Once we have allocated the Growth portion of your portfolio, that is, we have properly invested your strategic asset allocation, we then track the different components of it regularly to ascertain the trends being established by the respective markets. No one can predict what the financial markets are going to do, but with a little bit of insight and a lot of data, one can determine the general tendencies or trends. We look to have your portfolio fully invested most of the business cycle but we also look to sell certain assets or certain categories as their trend begins an apparent downward spiral. We anticipate offering some amount of insulation from future down markets by closely watching the trends of the various components of your market exposure assets and acting accordingly. Acting accordingly means that we will rebalance your total portfolio to our agreed upon policy or model every 6 months. That "forces" us to sell high and buy low - the direction you want to take.
In addition, and on top of your well-designed Growth portfolio, we may overlay the risk management strategy of dynamic asset allocation. Simplistically, when a specific market as represented by the chosen security (either an ETF or index fund as discussed earlier) is trading above its average price for a specific period, we may either buy or hold onto the security for that asset class. When the price of that security drops below its average price, we may sell that security. Selling the security does not indicate that we no longer “like” either that specific security or the asset class it represents. It simply means that our model is indicating that it is in your best interests to be out of that particular asset class at that particular time.
Additionally, we may sometimes use ETFs that perform inversely to their specific market. For example, if U.S. Stocks as measured by the S&P 500 index drop by say, 6%, an inverse ETF may actually increase by 6%. These inverse funds would potentially be used when an asset class as represented by its ETF falls below its average price and requires that we sell that ETF as in the previous paragraph. We would sell that ETF and then consider buying the market inverse ETF to take advantage of falling markets. We anticipate that by using these inverse ETFs we may eek out a bit more positive return in the long run. However, since markets historically have risen more often that they fall, we will be judicious in the use of inverse funds.
While this dynamic asset allocation has the potential to increase the total return of your portfolio over a full cycle, we view it primarily as a risk management technique. Know that during roaring bull markets such as we experienced in the 1990s, your portfolio may not return as much as the overall stock market. However, when the “bubbles” burst, as they always have and will continue to do, your portfolio may very well be spared some of the severe drops in portfolio value or what is known in the industry as “drawdown.” The financial markets have experienced some pretty large drawdowns in the last few years, but because of our attention to risk management, our clients' portfolios have held up rather well. Through the application of dynamic asset allocation, we intend to mitigate such losses in the future even more diligently. While no technique will insulate your portfolio from “shock” events such as October 19, 1987, the infamous "Black Monday" when the US stock market lost more than 20% in one day, the intent of implementing this technique is to allow your portfolio to grow along a smoother curve; to increase the statistical predictability of your portfolio; to make the bell curve steeper with fewer fat tails. Call us for more details.