This article is contributed by William G Ferrell, CIO of Ferrell Capital Management and the author of a new course on Global Risk Academy - "From Asset Allocation To Risk Allocation"
There is a lot to cheer about on Wall Street.
- Equity markets have performed well, particularly since the controversial US election.
- Earnings have been climbing
- Volatlity is low
- Demand for credit has increased the velocity and cost of money/return on cash
As always, investors are haunted by the “What’s next?” part of the puzzle.
o The last time we reached all-time highs – in October of 2007 – volatility was rising sharply as first signs of problems in the mortgage business were starting to appear like “Whack-a-Moles”.
o This time is different, as it should be, but high prices are as scary.
A lot has changed in eight years and the pace of change is relentlessly increasing as well. The results are mega-trends in the investment management business that will profoundly change the way assets are managed for capital market investors.
The vast majority of money managers have survived inferior investment performance through personal service including record keeping, tax and estate advice, and personal “relationships” that allowed brokers to sell “trustworthy” low value propositions to overcharged clients.
- Led by the persistent questions posed by frugal and common sense oriented millennials,
the new value system places business with:
o Low cost passive index investing
o Active management with lower fees (actually winning the battle over performance)
o Self- managed investment porfolios
The US stock market is at an all-time high. Falling off the 2007 market high was painful in the 2007-2009 financial crisis. The next crisis will probably be a result of a new kind of catalyst, and there are many to choose from. We could experience an explosion of sovereign debt that will gradually become more expensive than citizens want to pay, an unexpected credit default
– corporate, sovereign or mortgages (yet again?), or a geo-political event capable of major economic disruption. Never forget about “Lea Field”, the place that originates so many major problems we forget to consider until they happen.
- There is at least as much downside as upside potential in equity markets.
- Investors are starting to realize that protecting wealth is more important than getting left out of the remaining leg of the rally.
o Another vote for self-managed investments
As long as there is liquidity, one can reduce exposure as soon as the investor feels uncomfortable about world or market events.
Bonds have been useless for years. Now that the Fed has started to respond to the increase in the velocity of money, rates must rise; prices must decline.
- Investors who used fixed income for ballast to their stock porfolios have paid a price in reducing returns, but the rise of equity prices has marginalized the impact to acceptable absolute return levels.
- There could well come a time in the near future when both equities and fixed income become unsafe. Hopefully the economy will generate enough credit expansion to lift money market returns.
Transaction costs continue to fall, while retail brokers drag their feet to recognize that small fee cuts will soon become large discounts to compete with efficiency leaders like the block readers at large investment banks and efficient retailers like Interactive Brokers.
- Smart investors will find ways to use the new liquidity to their advantage.
- The rest will continue to be underserved and over-charged.
The use of ETF wrappers will continue to dominate industry cash flows. ETFs already provide useful tax relief for most investors.
- Lower capital gains taxes may draw attention, making them even more attractive.
- Minimal transaction costs will invite active management to increase participation in the dominate index business.
As one would expect, large money managers are facing lower fee income by marketing their growth on the basis of the tide rising faster than fees have declined. When the market “correction” comes, assets will decline, but the lower fees will remain.
The best solution is to make the best use of the above trends that may be exploited to an investor’s advantage while avoiding the predictable pitfalls. Make no attempt to predict when investment markets will misbehave – watch every day so that the next turmoil will be evident through the lens you use to monitor your assets.
- Information travels at the speed of the internet.
- Intuition from complex analytics can provide intuition and guidance in minutes.
- Execution is practically free.
- Exercise best practices because they are available and will ultimately be adopted by a growing number of prescient investors.
Avoid fixed income unless cash becomes the only safe haven from a high risk equity market:
Watch risk factors carefully
o Put/call parity will soon draw attention to market risk bias
o The VIX Index is not a reliable risk forecasting tool, but it describes sentiment very well.
▪ Low volatlity in the latest market advance has been fueled by low correlations
between market sectors and the relatively strong rise in corporate earnings
Allocate Risk, Not Assets!
If you do not know how to measure and allocate investment risk, find someone with the appropriate tools and mindset.
Follow the largest and most successful endowments and foundations to the risk allocation platforms.
Their leadership is focused solely on producing the best possible risk adjusted returns.
Unlike asset allocation - usually set for at least quarters or longer, risk allocation will require:
▪ Daily measurement of market conditions and the pace of change
▪ Reallocation based on market behavior
• Can be monthly or weekly
• When you need risk control the most – DAILY.
• Find a risk allocation strategy that seeks the best risk-adjusted returns
▪ And is willing to hide in cash if none are available.
▪ Take advantage of modern quantitative analysis that is fast, accurate and selfcontained.
If you want to study more about Risk Allocation, please check the new course developed by William G Ferrell, CIO of Ferrell Capital Management - "From Asset Allocation To Risk Allocation"
If it's a fit for you and you want to join, please hurry up - the current introductory offer is valid during the short period of time only.
As an additional bonus you will get a 1-month subscription for money . net valued at $150.