Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

3rd Quarter | 2021

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

By Jerry Wagner

Fences are usually used to separate property owned by two different people. Being “on the fence” means that you’re unable to make up your mind, unable to choose between two positions, balanced precariously, in neither one world nor the other.

It’s a phrase from Middle English that came into common usage in the 1800s. Today, it accurately depicts the position of a large portion of investors.

On the one hand, we have rising interest rates, stubborn unemployment, weakening GDP (gross domestic product), the Great Resignation, soaring inflation, and continuing COVID case and death reports.

On the other hand, we have relatively low interest rates, a continuing uptrend in stock prices, increased corporate earnings, and declining COVID cases and deaths.

It’s no wonder a large percentage of investors are “on the fence.” And if you are one of them, you know that sitting on the fence can be a huge pain in the butt.

If you jump down on the pessimistic side, you could miss the next leg up of one of the most significant bull markets in history. Some analysts are predicting that another 20%-plus growth spurt is just ahead. That sure beats almost nonexistent interest rates at the bank, and a bond market that most everyone is predicting is already in a bear market.

Maybe the grass does look greener on the other side of the fence, where everything is optimistic. Yet many market seers are making dire predictions of recession and dark days for stock market investors in the near future.

As a result, some investors will continue to sit on the fence. Most may decide to do nothing because, as financial behaviorists often tell us, the pain of taking a loss is more than twice as motivating as the pleasure derived from a gain. This explains why some investors have not returned to stocks since the 2007–2008 bear market. This has occurred despite gains of almost 600% in the S&P 500 since the stock market low on March 9, 2009.

What’s an investor to do? Invest? If so, when?

The present high level of inflation may be “transitory” like the Federal Reserve once believed, or it may be a harbinger of the return of the 1970s and the days of stagflation. Regardless of which camp you’re in, few would disagree with the notion that the stock market is a better place to be to defend against it than earning minimal interest in the banks or a sagging bond market. Historically, stocks and gold have kept investors ahead during inflationary times.

When it comes to the question of “when to invest,” numerous studies have concluded that the best time to buy is “now.” This research has demonstrated time and again that the upward trend in stocks has meant that investors have more to lose by waiting than they have to gain.

Of course, the 10-year holding period requirement used in the previous study is what troubles most investors. They don’t have forever to wait for the market to come back. They may be near the end of their earning years or already retired. They don’t have time to earn back their losses; they need to live off their earnings. So these investors have been very hesitant to buy into the “now” answer.

Dynamic, risk-managed investing was developed to make it easier to voice the “now” answer. Combining actively managed, multi-asset strategies in multi-strategy portfolios is designed to provide risk mitigation during major bear markets in stocks and take advantage of opportunities when markets are trending higher.

I often speak of the difference between “baby bear” markets (short, frequent, shallow market declines of 5%–20%) and “grizzly bear” markets (rare, long, deep market declines of 20% or more). The former are inconvenient disruptions that can be recovered from quickly, while the latter are killers that can put your portfolio in the hospital for a long time. It’s not the fear of baby bears that keeps people from investing. It’s the terror of a visit from the grizzly bear market that causes them to stay on the other side of the fence.

Building “antifragile” portfolios that dynamically manage market risk

Dynamic, risk-managed investing is just as susceptible to baby bears as a conventional portfolio, diversified simply by investing in different asset classes. But the responsiveness of dynamic investing, plus the noncorrelation introduced by portfolios of alternative strategies, has proven to be a better defense against the grizzly bear markets than conventional portfolios.

Resilience is the term I like to apply to this type of portfolio. First and foremost, a resilient portfolio seeks to maintain the status quo. It aims to not slip backward. It is durable, and we provide a Durability Score to measure its resilience.

Robustness is another term that better practitioners of dynamic risk management seek to deliver. They accomplish this by using multiple asset classes and many active strategies to not be too dependent on any particular market environment. These portfolios are built to not only test well in the past but also thrive in the future. They are thoroughly walk-forward tested for their robustness.

Finally, the ultimate goal of a risk-managed portfolio is to reach a level of “antifragility.” As the concept developer, Nassim Taleb, writes, “Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.”

Nobody wants a portfolio that can be called “fragile.” A vase that falls will shatter. While difficult to change for better or for worse, a rock won’t shatter or quickly waste away—it is resilient.

But if something is antifragile, it prospers in the face of any type of change, whether positive or negative. It actually improves with risk or volatility.

In this time of COVID, think of the concept of our body’s immunity. A person surviving COVID has substantial immunity to the virus. One Israeli study has determined that that immunity is 27 times greater than even a vaccine can deliver. This does not mean that COVID survivors are imperious to another bout of the virus. Still, it does demonstrate how our immune system is antifragile—it is made better by going through adversity.

How can you tell if an investment strategy is antifragile?

One approach is to use Flexible Plan’s Crash Test Analyzer (available on flexibleplan.com to financial advisers after login). One of the functions of this tool is to create a Strategy Crash Test Report that compares a strategy or strategies to the performance of the S&P, bond, and gold indexes during positive and negative economic regime stages. The Strategy Crash Test Report can be created using research report data (hypothetical data with available data back to 1998) or with model data (actual account results for the strategy back to its inception).

For example, you can create hypothetical research report results of our QFC Fusion 2.0 Growth strategy during rising and falling inflation periods from 8/01/2002–9/30/2021.  It would disclose that there is very little difference (0.7%) between the performance in the two different regime stages, and further that the better period is when inflation is rising! No reason to put off buying on that account.

The performance of the same strategy during rising and falling volatility regime stages only differed by 0.8%. And both rising and falling interest rates yield profits with the methodology (although rising rates did reduce earnings by 8.3%).

The Crash Test Analyzer looks at 30 different regime stages like this, examining performance for interest rate changes, GDP, the dollar, market volatility, and gold and bond market direction. It even drills down to the strategy’s performance in different economies—normal, ideal, stagflation, and deflation (the QFC Fusion 2.0 strategy made money in all four in the report).

The Crash Test Report provides a measure of resiliency with its Durability Score. The Durability Score tells us in how many of the 30 regime stages the strategy actually made money. With 30 being a perfect score, QFC Fusion 2.0 registered a 27.

The Crash Test Report does not provide an actual antifragility score. However, Taleb and other writers suggest that the best way to construct such a score is to see how the model being tested performs under positive and negative stress versus the underlying model’s baseline.

In the same vein, the Crash Test Report provides a total of how many times the strategy outperforms the S&P, bond, and gold indexes. With 30 regime stages and three indexes, a perfect score would be 90. That would be genuinely antifragile in my book. The score for QFC Fusion 2.0 is 73, which is outstanding.

QFC Fusion 2.0 is just one example. Similar analysis can be computed on scores of FPI strategies (for example, on all of the 50-plus QFC risk profiles and strategies).

In addition, we include a version of the Crash Test Analyzer in our Illustration Generator tool. Since this tool allows users to create a report of a portfolio of strategies rather than a single methodology, advisers can use it to determine the durability of a portfolio. An estimate of antifragility can also be determined by looking at the score against the portfolio’s benchmark, which is also provided in the report.

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It’s OK to be on the fence if you don’t have the information necessary to climb down on one side or the other. But our investing tools can help you locate the strategies or portfolios that give you the best opportunity to prosper whether the market or economic regime you most fear occurs or not.

Dynamic, risk-managed investing can bring resilient, robust, antifragile management to your portfolio.

With that advantage on your side, there’s no reason to stay on the fence. You can invest now. The tools are here at Flexible Plan Investments to allay your fears, whatever they may be.



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