Combine an increase in market volatility, signs of a possible major trend change (bullish to bearish) for the first time since early 2009, and a non-traditional portfolio approach like the one we take at Sungarden, and the question is inevitable: "why is it that on down days, my portfolio protects pretty well, but on up days, I often don't participate in much of the move?"We have had this question from a few clients recently. And while discussing short-term portfolio and market behavior opens a Pandora's Box of discussion points, we'll tie that question to a brief review of some the key aspects of a hedged approach to investing like ours. Here are some of the key factors at work:

 

1. BETA - this is a measure of a portfolio's volatility. It is measured in both directions and combined into a single figure. For instance, a Beta of 0.50 means that you have, on average, been half as volatile as the market (S&P 500 is typically "the market" in these calculations but it can be anything). As far as our question goes, a portfolio's Beta is not something that should be expected to be consistent every day. Now, if you had half of your portfolio in an S&P 500 Index mutual fund or ETF, and 50% in cash earning nearly zero return, you could approximate a .50 Beta each trading day. But we strongly suggest trying to apply a longer-term principle like Beta to a day, week, month, etc.

 

2. TIME FACTOR - following on that conclusion, you may be asking "why isn't it my portfolio's volatility consistent from day to day?" Since it has been a while since we've used a baseball analogy, here's one: a major league baseball team plays 162 games in the regular season. That's a long, long season. During that season, even the best teams can lose four, five, six or more games in a row and still win a championship. Portfolio strategies go through slumps too. And it often has more to do with the whims of traders and speculators than anything that will matter in a few months or years. Investing is full of temporary issues.

 

Now, if an NFL football team lost six games in a row, they are unlikely to win the Super Bowl. Our advice to you: think of portfolio management as akin to a baseball season instead of a football season.

 

3. CONCENTRATED PORTFOLIO / CORRELATION - these two factors in Sungarden portfolios are probably the most important part of our answer to the key question asked at the start of this blog. We run concentrated portfolios. That means we typically own around 20-25 stocks. As you can imagine, in any day, week, month or quarter, a strong or weak performer in the portfolio will show up more in the total portfolio's performance than a single stock within the S&P 500. A good example of this has occurred in 2014 between the S&P 500 and the Dow Jones Industrial Index. The S&P is 500 companies, the Dow is only 30. Some years (like this one), there can be a fairly wide gap in returns between the two major U.S. stock indexes. A few bad apples in the Dow (performance-wise) and a dearth of high-flyers in that index has caused the S&P to outperform so far this year. So, stock holdings within concentrated portfolios do not "correlate" with each other: that is, they don't all zig and zag together.

 

4. HEDGED INVESTING - that's what we specialize in at Sungarden. But the "short" or defensive side of our portfolio is typically invested in inverse ETFs, which move opposite a major market index. That will usually limit both gains and losses over short time periods versus a fully-invested, all-stock portfolio or index.

 

FINAL THOUGHTS: as with many other money managers, it is not our goal to track the S&P 500 Index. It is far more about delivering the long-term return a client needs to live the way they want to live. We pursue this through a hedged investing approach. 

Rather than try to out-guess the market's trader element, we prefer to act consistent with what our objectives are for each strategy. Avoiding the big loss is a prime part of that. Tracking bounce days when market activity is getting increasingly concerning to us is not. Boring? Yes. Effective at keeping our clients retired? We think so.

© Sungarden Investment Research

www.sungardenresearch.com

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