Market insights and analysis

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

4th Quarter | 2023

Quarterly recap



Current market environment performance of dynamic, risk-managed investment solutions.

By Will Hubbard

I love traveling to New York City, taking a break from my usual day-to-day routine by riding the subway, walking the crowded streets, and people-watching. I especially enjoy observing the hustle and swift adaptability of the street vendors. When the sun is shining, you can expect to see the iconic I Love NYC shirts and similar souvenirs on display for tourists to buy. But at the first sign of a storm, these savvy merchants become one-stop shops for umbrellas.

As an eternal optimist, I rarely carry an umbrella when I travel. I assume the sun will always shine, resulting in more unfortunate weather-related incidents than I care to admit. However, when it comes to investing, I’m always prepared for a storm.

When financial clouds roll in, will your portfolio be ready?

Portfolio drawdowns can be a major hazard to your financial nest egg. While it’s normal to experience small drawdowns on your investment journey, steep and persistent drawdowns can be catastrophic. Investors in Japan’s Nikkei Index know this firsthand.

U.S. investors experience home bias (preferring domestic to foreign investments) more than any others, thanks to our historically robust equity markets. The upside is that we’ve had strong equity markets over the last 30, 40, and even 100 years, giving rise to the “hands-off” passive equity investors. The downside is that we sometimes consider ourselves immune from events happening outside our borders and believe that markets will always recover quickly.

Passive investors in Japan’s Nikkei 225 Index are akin to the “Buy SPY or die” group in the U.S. It’s been 35 years since the Nikkei broke to new highs, and while its run from 2010 has been admirable, the return to breakeven from an 80% decline, like that of the Nikkei, is still 400%.

That experience is what some disruptive technology investors in the U.S. are facing right now. For those that bought into Cathie Wood’s funds (such as ETF ticker ARKK) back in 2020 and 2021, the experience has been extremely challenging and likely frustrating. Even though shares are up over 40% year to date, they’re a long way off the all-time highs.

This isn’t to say this type of investment strategy is without merit or that investors should sell their shares. In fact, according to AARP, “The greatest threat to your retirement account balance is selling shares when the stock market is falling. The reason: You will need to sell more shares in a down market than in a healthy one to come up with the cash you need.”

The point is that having a risk-management plan to minimize the potential of these types of drawdowns is critical to long-term investing success. Whether it’s index investing, specialized fund investments, or single stocks, a risk-management plan will help reduce the risk of a catastrophic drawdown.

Today’s conditions are sunny …

Currently, the NASDAQ, S&P 500, and even Cathie Wood’s ARKK ETF are experiencing strong gains, up 39.9%, 16.8%, and 45.8%, respectively. Unemployment remains historically low at 3.5%. The Federal Reserve’s attempt at an economic “soft landing” seems to be working, inflation is slowing, and the University of Michigan Consumer Sentiment survey is up almost 40% over the last year—signaling returning investor confidence.

Even managers who focus on risk are moving toward equities. The National Association of Active Investment Managers (NAAIM) Exposure Index shows manager allocations to equities have increased substantially over the last year, up to 78.46 from 55.28 a year ago. For reference, an index of 100 indicates 100% long.

We analyzed the one-month, three-month, and one-year returns for the S&P 500 based on the most recent allocation reading and found that the returns are positive on average across each period.

What we found interesting, though, is that the range of potential outcomes from these levels is wide, especially on the one-month and three-month scales. The S&P average one-month return when the NAAIM Exposure Index is at 78.46 or above is 0.40%, with the best being a gain of 8.3% and the worst a loss of 28%.

These numbers include the COVID drop. But even without considering that, the average one-month return is 0.57% and the worst loss is 10.36%, a skewed risk/return.

… But investors should always carry an “investment umbrella”—just in case

The market and some strategies have performed well this year, but this doesn’t mean investors should be complacent. Because of the damaging effects losses can have on portfolios, it’s important to always have a plan to manage risk and drawdown.

I may continue to walk around New York City without an umbrella, but the most I’m risking is getting my suit wet and maybe catching a cold. Investors without “investment umbrellas” risk much more, including portfolio losses that jeopardize long-term financial and life goals.

If you don’t have an investment umbrella, consider talking to your financial adviser to discuss developing a risk-management plan for your investment portfolio. They can be pretty easy to implement (thanks to turnkey multi-strategy, risk-managed investment solutions like those available from Flexible Plan Investments) and extremely helpful in protecting you from an unexpected financial storm.

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