Remember Risk?

It seems to me that US stock market investors (with the S&P 500 making more new highs) are having a grand old time. Everybody is happy when the market goes up.

Closer to home, it is definitely not happening for the SP/TSX. If you have too much "home country" bias in your portfolio, which according to the MSCI All Country World Index (ACWI) should only be about a 3% weighting of Canadian companies. This same index has a little over 50% weighting in US companies.

At the end of Q2, the I-shares ACWI ETF (total return) was up well over 18 1/2% since the same time last year. However, in spite of that performance, the 2 and 3 year annual average returns have remained well below average.

The other factor for a Canadian investor with a balanced portfolio is the fixed income side of the equation:

The Canadian bond index ETF (XBB) has struggled, putting in a mildly negative return over the last year and of course has pulled the total return of a balanced 60% equity / 40% fixed income portfolio to a level just under 10% (after adjusting for fees).

And of course the 2 and 3 year average annual returns have been well below the 5 year average annual returns.

If stock market's (in the US) are reaching their peak (and a good argument can be made for that, because US economic growth is struggling to get to 2%), the 1 year total returns (for fully invested 60 / 40 portfolios) are likely in jeopardy. 

What do you do to protect any of these gains?

Get tactical!

When you focus on the return per unit of risk taken, you can see that these 60 / 40 portfolios have ever increasing amounts of risk, which leaves them enormously vulnerable to any downside in the US stock market. Potentially taking away a good deal of the gains made over the previous year. And make no mistake, there are significantly elevated levels of risk out there at this time.

The risk level for the 60% ACWI /40% XBB portfolio over the last 4 years has been about 4.6. A more tactical approach as represented by the Actual HR PC portfolio is closer to risk at 3.

If you take the total return over the same time frame and divide by the risk factor, it is easy to see that the more tactical portfolio has a significantly better return for the unit of risk taken (3.01 vs. 1.60).

At High Rock, we manage risk first. Our first priority is to protect our and our clients capital.

Do you know the level of risk in your portfolio?