Getting ahead by not falling behind

Max Osbon - March 26, 2013

Over time unforeseen risks can and will accumulate in a portfolio. Interest rate risks, market risks, inflation risks, default risks, and the risk of improper diversification are examples of potential pitfalls that must be persistently monitored.

Some of these risks are welcome – they bring the opportunity for greater returns. But others bring too much downside, with little or no opportunity for additional gain. Managing a well-diversified investment portfolio comes with the responsibility to identify and correct the accumulation of those unwanted risks (often called “uncompensated risks”).

Here’s a recent example of accumulated risk causing problems in “set it and forget it” portfolios:
Mid to long term duration bonds.

Remember that bond prices move in the opposite direction of interest rates. When interest rates were falling, as they have fairly consistently over the last generation, the market prices of existing bonds rose considerably. But now with interest rates at historic lows and very little room to fall any further, an allocation to mid-long term bonds simply has a very limited upside. However, with no limit on how high rates could go in the future, there’s boundless downside risk.

Holding these bonds means locking in to rates that can leave the investor losing ground if interest rates or inflation rise. It’s a danger affecting set it and forget investors who fail to monitor for unwanted risks.

Take risks that provide potential return

Isn’t a move out of mid-long bonds a speculative “active management” decision? No. We don’t recommend re-allocating assets to chase the best performing sectors, as active managers do. But we do recommend reducing or eliminating those risks that have become unnecessary. Again, this is not to be risk averse; we like risky assets because they provide the opportunity for returns. What we don’t want is to continue to hold assets that don’t balance risk and return.

As we mentioned in our recent article Why Do Allocations Change, the reason we make changes in asset allocations is to keep things unchanged. We rebalance to put portfolios back in line with client goals and to protect the relationship between risk and return. Modifications may be small, but attention to detail is important. Small repairs can make big impacts – especially when compounded over a generation.

Just as CEO’s constantly look for opportunities to increase their bottom line by cutting unnecessary costs, investors can boost potential performance by eliminating these unnecessary risks. That means monitoring for imbalances in all market conditions.

Max Osbonmosbon@osboncapital.com

Print Friendly, PDF & Email

Disclaimer

  • This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”
  • “Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.
  • Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.
  • Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.
  • This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.
  • While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.
  • Adviser does not endorse the statements, services or performance of any third-party vendor.
  • Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.