With stock markets pushing all-time highs, it’s tempting for investors to relax and bask in gains.
Instead, this should be viewed as an opportune time to protect gains and strengthen portfolio resilience.
Modern diversification strategies, macro awareness and active management are vital tools in this process.
The financial press has been all a-flutter, of late, with talk of new highs across U.S. stock markets. Indeed, the Dow Jones Industrial Average set a new all time closing high in March. Meanwhile, the S&P 500, as of this writing, sits less than one percent below its all time high. The surge in these well known market bellwethers in recent months feels good, and no doubt tempts investors to bask in their portfolio gains, and to ease back in their fussing over the nuances of investment strategy.
Investors should resist this temptation. Instead, we suggest that they view the return to record highs in equity markets as an opportunity to review and strengthen — not ignore — the nuances of portfolio strategy, particularly portfolio resilience. Indeed, how many of us wished, in the depths of the financial crisis, for a second chance to protect our squandered peak portfolio values? Well, recent market strength has given us that second chance.
The most important tool that investors control to improve portfolio resilience is diversification. Diversification has, of course, been a central topic in investment strategy for many decades. However, I believe that the science of diversification has advanced considerably over the last decade. Not so long ago, investment strategists considered a portfolio with capital allocated across global stocks and global bonds to be well diversified. Today, not only has the set of building blocks included in a portfolio expanded, but also the methodologies for determining an effective asset mix have progressed. Modern portfolios combine not just stocks with bonds, but financial assets with real assets, traditional investments with alternative investments, and passive strategies with active strategies. Furthermore, savvy investors today determine the allocations to these categories with an eye towards balancing risks, not capital. Today’s high portfolio values provide an excellent occasion to deploy these advanced diversification techniques to strengthen portfolio resilience.
Two other important tools have gained relevance in recent times, as buy and hold strategies have struggled. Macro awareness is one, and opportunistic active management is the other. Both can make a contribution to portfolio resilience. Our weekly Perspectives provides insight in each of these areas. Note that many equity markets around the world are struggling even as the U.S. market surges towards new highs. The importance of regional allocation has returned, and markets in Europe may continue to struggle if the region’s economic performance does not improve.
The year 2013 is off to a great start, but is not even one quarter elapsed. Minding the nuances of diversification, macro awareness, and active identification of granular opportunity can help investors combine the pursuit of further gains with the sensibility of capital preservation.