In 2019, the bull market thinking of fixed income investors argued for a more disciplined approach to risk and return. The markets today are facing very different circumstances, but are suffering from the same lack of risk management. This is in part due to a broad-based misinterpretation that the Federal Reserve will bail out corporate credit[1], and in part due to the explosion of day trading by risk-seeking individuals with nothing better to do in quarantine.[2] Furthermore, we still have a global pandemic on our hands, with a virus that appears difficult to understand and that no one seems to be able to agree how to address. And much has been made of the science therein and what we do and don’t know about COVID-19. But with this uncertain backdrop, two things are clear to us: If you listen to the science, you wouldn’t buy the market now…and you wouldn’t sell it either.

Our point here is not to litigate the correctness of one set of policies or another. The reality is that reasonable people can disagree, and contradictory conclusions can often be drawn from the same set of facts. In the financial markets, we can see that the one underlying theme here is a decided lack of risk management experience. After all, if an investor ever set out to avoid all risks, she could never expect to generate anything more than a risk-free rate of return except for by good or bad luck as a result of failing to identify a hidden risk in her portfolio. Meanwhile, if that same investor chose to take a risk because it could not be proven that it would definitely turn out badly, then every risk would seem worth taking. As we have said many times before, just because a risk doesn’t manifest itself doesn’t mean it doesn’t exist. Neither of these approaches would result in a reasonable balance of risk and reward in an investment portfolio.

The hard truth is that investing is inherently uncertain, and the most successful investors over the long-term are those who take calculated risks. In an era where portfolios are evaluated based on short-term performance, identifying such investors becomes a more difficult task than it should be. But, just as with good public policy, a good investment strategy is one that weighs many oft-contradictory factors and aims not to minimize risk or maximize return but to optimize risk/reward. This is not a portfolio that should be expected to always “outperform” broad-market benchmarks, nor is it a portfolio that should be expected to avoid having any risk manifest itself. But by aiming to take those risks that may come with asymmetrically positive returns and to avoid returns that may come with asymmetrically negative risks, one may be able to construct a portfolio that is better positioned to capitalize on uncertainty.