Perhaps one of our strongest character traits is our ability to forget and move on. Indeed, we collectively took the needed steps during the 2008 financial crisis and the markets have now recovered to new highs. But another thing that I have learned in my twenty-five years as a research analyst and money manager is that sometimes we need to remember in order to avoid repeating the same mistakes twice. This idea has been on my mind of late. Over the last five years I have been watching the temperature of advisors vacillate with the markets. We have just undergone another shift over the last six to nine months.
When I began to speak regularly with advisors in 2009, there was still a religious fervor in the active vs passive debate. To mention active management to a passive investor was the fastest way to end a conversation and be shown the door. Stay the course and time will eventually bail out poor returns. To do otherwise is folly.
That fervor began to give way to practical business considerations in the summer of 2011 when markets declined by 20% in response to the European financial crisis. Having just endured two major bear market declines in less than a decade and now facing a possible third decline, many of those die-hard buy-and-holders began to soften around the edges. They understood what the passive playbook would deliver in a third decline and feared another round of disappointing returns might cause clients to declare “three strikes and you’re out!” So a concerted effort began to identify a risk-managed tactical solution that would allow advisors to keep pace when markets were rising but reduce downside capture when they were falling. Preserving the practice and safeguarding client assets trumped religious ideology.
In the fall of 2012, some advisors began to waiver and reverse course once again. Faced with steadily rising markets that were now approaching the old highs, many advisors found their old convictions and renewed their faith in passive, buy-and-hold strategies. They discontinued the search for a risk-managed solution that would protect their clients and their revenues from another 2008 in favor of riding the Bernanke wave without a seat belt. Damn the torpedoes, full speed ahead!
Which begs the question: are advisors falling prey to the same market sentiment driven behavior that they ask their clients to avoid? We believe the time for prudent risk management is ALWAYS, but especially when markets have been vigorous for so long. And risk management amounts to more than just diversification and patience. It means making sure you do not own overvalued assets. And that may mean some measure of tactical adjustments in the portfolio. Not to mention the fact that time may bail out markets but they will not necessarily bail out your client when returns are back-end loaded (see video by Ken Solow).
Lulled to sleep by years of positive performance, many investors failed to manage risk in 2008 and clients paid dearly. Let’s hope advisors learned their lesson in 2008 and are not making the same mistakes again. This is a game about prudently managing risk so that you can steadily compound returns towards client retirement goals. Let others get carried away by recent exuberance.
