ETF Popularity, Complacency = Bigger Risk

Each week, like the proverbial broken record, we tell our clients (and any one else who cares to listen) on our weekly client webinar that the changing dynamics brought on by extraordinary monetary policy and liquidity by central banks since the financial crisis have made the old balanced portfolio correlations between equity and fixed income significantly less stable.

In other words, if you are using that "old-school" buy and hold methodology you have way more risk than you likely should have and are vulnerable to permanent portfolio damage if you (or your advisor) do not take the time to assess it.

At High Rock we manage risk first and foremost, so we have a full understanding of exactly what risk our clients (and we ourselves) have.

We often rail against the complacency factor: Canadian investors with global equity exposure have watched (if they pay attention) their portfolio values erode as the Canadian $ strengthened by over 10% (that is where the volatility has been). Did your advisor point out that risk to you?

There are greater risks out there: Asset prices have decoupled from their underlying fundamentals because central bank liquidity has put a temporary floor under them.

Corrections in market prices have not been significant as a result.

However, this liquidity is going to disappear (as central banks unwind their extraordinary monetary policies (the US Federal Reserve will start in October) and asset prices and the gap between them and the fundamentals will revert.

The big question is will the lagging fundamentals (like economic growth and inflation) catch up to extended asset prices or will prices fall to more realistic levels?

The big risk is the latter (obviously) and we all need to be prepared for that. If you are not, you could be in for a nasty surprise.

At High Rock, we are prepared. We are underweight expensive equity assets and over-weight cash. We are positioned to protect our clients. We do not use bond ETF's. They are expensive and don't allow us the flexibility necessary to adjust the average duration of our bond maturities. We are tactical: looking for real opportunity as opposed to owning over-priced assets.

Our (Paul and my) voices (blogs) do not get enormous exposure, likely a couple of hundred views per blog or thereabouts. And our profession is not journalism. So our message is not necessarily as far-reaching as some.

But when great voices on this topic echo our sentiment, it is always reassuring: so I would recommend having a peak at this conversation between a great market economist, Dr. Mohamed El-Erian and WealthManagement.com.

In words way more eloquent than mine, Dr. El-Erian suggests that "there is a difference between the investment journey and the destination". 

The investment journey being the day to day, week to week, month to month, year to year swings in portfolio value. The destination, of course, is your long term goal. Sometimes it may seem that the journey may not be taking a direct route to the destination, but you have to keep your eye on the target and let the capable managers worry about the day to day, etc. journey.

That is what we do: protect ourselves and our clients from risk that may impact the ultimate destination. Do you know for certain that your advisor is doing the same (especially if you are loaded up, like the rest of the mostly unsuspecting investing public on ETF's)?

Be aware of your risk. We can help.