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

4th Quarter | 2023

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

By David Wismer

My wife and I have become big fans of “Clarkson’s Farm,” a show on Amazon Prime.

It is a funny, beautifully shot, and uplifting documentary series that follows the victories and travails of Jeremy Clarkson (who you might know as one of the hosts of the BBC motor show “Top Gear”) as he attempts to operate a 1000-acre farm in the scenic Oxfordshire section of England. Clarkson purchased the farm in 2008, but it had been previously maintained on a contract basis by a local villager until his retirement in 2019.

Clarkson repeatedly shoots himself in the foot at what he now calls “Diddly Squat Farm.” While having virtually no background in farming, he somehow manages to raise crops and deal with his growing collection of chickens, sheep, and cows. Aside from the normal challenges of farming, Clarkson also faces the unforeseen complications of Britain’s COVID shutdown, rain and flooding of “biblical proportion,” disappearing farm subsidies and lower European agricultural demand due to Brexit, and a maze of restrictive local zoning regulations.

Despite these obstacles, Clarkson keeps his cynical sense of humor and demonstrates a deep attachment to his animals, respect for the environment, affection for his support team, and a desire to help neighboring farmers. He is delighted whenever he actually does something right, exclaiming, “I did a farming thing!”

I highly recommend the show. You can see the season 2 trailer here.

A willing suspension of disbelief

Our daughter visited last weekend and we all watched a few episodes of “Clarkson’s Farm” together. She liked the show but wondered, “Can anyone really believe someone could be so unprepared for a new venture?”

I said, “You just have to have a willing suspension of disbelief.”

A willing suspension of disbelief (WSD) means to allow oneself to believe something is true even though it seems highly unlikely or even impossible.

During my years in the communications industry, I came to realize how big a role the “willing suspension of disbelief” plays in many successful movies, commercials, TV shows, plays, books, and just about any creative endeavor. Alfred Hitchcock and Rod Serling were masters of WSD. Steven Spielberg, Andrew Lloyd Webber, J.K. Rowling, and many others are more recent examples.

WSD also plays a big role in behavioral finance, explaining to some degree the major mistakes self-directed investors can make.

Investopedia writes, “A basic characteristic of financial bubbles is the suspension of disbelief by most participants when the speculative price surge is occurring: It’s only in retrospect, after the bubble has burst, that they’re recognized (to many an investor’s chagrin).” 

Think about the “unbelievable” run-up in tech stocks fueled in part by the dot-com craze in the late 1990s and early 2000. This was followed by a crash of over 70% for the NASDAQ Composite. It took about 15 years for that index to get back to breakeven. More recently, we saw an explosive and highly speculative move higher in the price of bitcoin in 2020 and 2021, only to see it fall by about 75% in late 2022 before recovering some of its losses in 2023.

In both cases, investors believed in a market trend that might have seemed implausible. They thought (or wished) prices could move even higher—putting their assets at great risk. WSD is related to the behavioral biases of recency bias and herd mentality. Investors not only believe that a strong trend in the markets will continue indefinitely, but they also find confirmation by seeing other investors believing and doing the same thing.

While the dynamics are somewhat different and more limited to a specific investor class, the ups and downs of so-called meme stocks could fall into the same category of WSD boom and bust—though it has varied greatly by each stock.

Performance of the MEME ETF since its December 2021 launch

MEME, an ETF that invests in “securities of companies that exhibit a combination of elevated social media activity and high short interest,” launched in December 2021. The results have not been good, to say the least, with $10,000 invested in MEME at launch now down to under $5,000.

A behavioral finance perspective

A recent article in Proactive Advisor Magazine by behavioral finance expert Richard Lehman delves into many issues related to behavioral biases. Lehman says “fear and greed” are natural emotions for any investor and it is unrealistic to expect that they will ever disappear.

But he also says one of the most important roles financial advisers can play is in helping their investor clients find the right portfolio approach that helps minimize their likelihood of having “regret” over portfolio performance. This means helping investors recognize what their risk profile actually means, and how they can strike the right emotional balance between “the fear of missing out on market gains” and “the pain of taking actual portfolio losses.”

He devised a simple model or conceptual approach for his premise, where advisers need to help guide clients in avoiding the “maximum regret zone” in the lower right quadrant.

For clarity, a “low opportunity loss” might mean an investor’s diversified portfolio saw a return of 10% in a year when the S&P 500 returned 12%. A “high opportunity loss” might represent a year when an investor in a portfolio dominated by fixed-income investments saw a gain of 4.5%, while a portfolio with significant exposure to the NASDAQ 100 Index ETF (QQQ) returned 22%. 

While all investors would certainly like to finish every year in the upper left quadrant, that is not always going to be a realistic expectation.

Lehman writes, “The minimax-regret decision protocol doesn’t attempt to build mathematically optimal portfolios. It attempts instead to help the client envision different scenarios and to express a preference for a strategy that minimizes their potential regrets. Armed with that information, the advisor can create a portfolio that either addresses those regrets directly or balances them with potential opportunities.”

I think Lehman’s conceptual approach is entirely compatible with the investment philosophy of Flexible Plan Investments (FPI). FPI helps advisers build client portfolios all across the risk spectrum, from highly conservative to aggressive. But for all portfolios the broad methodology remains the same: non-emotional and rules-based strategies, used in combination, that seek competitive returns in line with a client’s risk profile—while striving to mitigate risk.

One of the advisers we interviewed for Proactive Advisor Magazine put it well, saying that a dynamically risk-managed portfolio approach has three major benefits for his clients: “(1) the psychological benefit of knowing their investment strategy is predicated on smoothing out volatility; (2) the tangible mathematical and compounding benefit of avoiding deep losses in their portfolio; and (3) having an investment strategy that is customized to their risk tolerance.”

You don’t have to “willingly suspend disbelief” to see the sense of that.



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