Active Management Adds a Defense
In Financial Markets, as in Life,We Need to Accommodate Change
Traditional investing, with its focus on fixed asset allocations and historical data to diversify investments, is based on the expectation that past performance does forecast future returns. Since the historical long-term trend of the market has been up, the expectation is that it will continue up over time.
There are many weaknesses to this approach, number one of which is that it leaves portfolios fully exposed to bear markets. The stock market has historically outperformed virtually all other investments, but at the cost of subjecting investors to great volatility. Between 1929 and 2012, there have been 15 bear markets, defined as those periods when the S&P 500 has fallen at least 20%. The average bear market slashed more than 38% from stock prices. Omit the ’29 crash, when values declined 87%, and the result is still an average loss of 35%. After eliminating overlapping bear markets, investors have spent 2/3s of their time over the last 80 years either suffering through a bear market or returning to breakeven. Only one third of the time were they benefiting from the stock market’s ability to make their investments grow in value. That is not a very efficient way to make money.
Active management, as we define the term at Haas Fydroski Financial Services, is risk management with an opportunistic bent. We use technical market analysis to determine periods of high risk and adjust our clients' portfolios to reduce market exposure during those periods and then to move back into equities and other investments when the market enters a lower-risk up phase. Active management also provides an opportunity to adjust portfolio positions to focus on sectors of the market that signal opportunities for outperformance in the current market environment.
Naturally, there can be no guarantee that active management will be successful in lowering portfolio risk and targeting areas of outperformance. Nor will every portfolio adjustment be profitable. There will be times when, in taking a defensive posture, we will miss an up move. This is not a new investment strategy for us, however, but one we have implemented for more than 10 years. Naturallly, past performance is not indicative for future returns.