Crash course in portfolio management, Part 3


In this series, I’ve been exploring what professional money managers do when market turn volatile. With my 10-step methodology I begin by developing informed opinions by looking at trends, patterns, and relationships. I then quantify risk. In the final three steps, I zero in on assessing investor-specific decisions, including how to deploy cash cushions.

7. Testing trading strategies

article continues below

With the overall portfolio now in mind, our attention then shifts to the individual circumstances of the client. To test our trading strategies and conviction, we typically probe deeper into gauging possible outcomes:

What if we are wrong in our assessments? What if we make our planned changes and the market responds in the opposite manner? How will our decisions positively and negatively impact a client, based on their unique circumstances today? For example, what if the client has a small portfolio but a large pension plan? Will larger changes in their portfolio negatively impact their retirement income picture? If the answer is no, then perhaps we will choose to postpone some rebalancing decisions.

Alternatively, what if the client has a large portfolio and is relying on this portfolio for the bulk of their day to day retirement income? If we were to “stay the course” but if the market were to move against us, how would this negatively impact the client’s retirement income picture? Again, these are risk-management decisions that are important to consider as they pertain to the personal circumstances of the investor.

I will emphasize again our principle that the markets are going to do whatever they are going to do, in whatever timeframe that they take. What we “hope” or “think” or even forecast is immaterial. The markets owe you nothing. The markets don’t have to behave well for you just because you are approaching retirement. Instead, the market giveth and it taketh away. Your objective is to “keepeth” what you have, and to achieve a return higher than GICs and with as little risk as possible.

In our methodology, we start by assessing the market, its trends and its level of risk. We do a similar assessment on individual securities and on the investor’s overall portfolio. But to make good decisions, we also need to consider these decisions in the context of the age, stage of life, and economic position of the investor. Yes, in my world, all of these factors come into play when making decisions each and every day on what to own, what and when to buy and sell, and whether we do this gradually or in larger steps. In our view, the primary objective of portfolio management is “risk management.” When risks are managed, returns inevitably come. This has been our experience.

8. Deploying cash

A perennial question is what to do with the proceeds if we have trimmed or sold a position. In our process we continue to evaluate new investment options in a similar, risk-focused manner. Given the declines in the Canadian market dating as far back as September 2014, there are many securities that have seen declines of 20% to 50%.

In the same way in which securities that have gained considerably in value may represent higher risk, those securities that have declined considerably in value mayrepresent higher opportunity. Therefore, we then begin a thorough process of evaluating the downside risk and upside opportunities of other investment options.

In most market environments you will always find those areas that are gaining in value while the majority of others are declining. Going back to Step #1, by looking at the trends throughout the market (regions, asset classes, and sectors), you may be able to find some “hints” to which areas in the market to review further when looking for new investment opportunities.

When you have a process for evaluating individual investments, then you will also begin to formulate a clear process for determining your “buy strategy” and your “sell strategy.”

9. Disciplined investment strategy

What if you simply can’t find any investments that meet your buy strategy? In this case, you simply hold on to your cash. This important discipline has served us well over time. Patience, especially when investing, can definitely be a virtue. If an investment meets your sell criteria, and the sell criteria have served you well in the past, then follow your discipline, even if it doesn’t seem to make sense to you today. In the coming days, weeks or months, you may be very glad that you followed your discipline. Similarly, if you are holding cash and your research isn’t unearthing new investment options, then keep your cash. Set it aside in a liquid higher-interest account that will readily available when you do find something that you wish to invest in.

10. Repeat

This brings us to step 10: Repeat steps 1 through 9 on a regular basis. When markets are volatile, do-it-yourself investors should work through this process every couple of days. When markets are calm and you are more fully invested, repeat this process every one to three weeks. This is the process that we work through when evaluating markets, securities, portfolios, and client circumstances.

Be consistent

It has been said many times and in many ways that the best investment strategy is a buy-and-hold approach. I want to reiterate that I do not use the buy-and-hold approach. This doesn’t mean that it’s “wrong.” Instead, I take a different view.

A buy-and-hold approach is effectively a “consistent strategy” of holding through the highs and lows of the market over time. In my view, it is the consistent strategythat is most important. Most strategies work over time, just in different ways. Therefore, my advice is for you to develop a strategy that you feel works best for you (for example, using the methodology I’ve outlined in this series) and then stick with this strategy over time(tweaking as necessary, when necessary).

Courtesy Fundata Canada Inc. © 2016. Doug Nelson, B.Comm., CFP, CLU, CIM, is President of Winnipeg-based Nelson Financial Consultants. This article is not intended as personalized advice.

© Copyright Battlefords News Optimist


NOTE: To post a comment you must have an account with at least one of the following services: Disqus, Facebook, Twitter, Google+ You may then login using your account credentials for that service. If you do not already have an account you may register a new profile with Disqus by first clicking the "Post as" button and then the link: "Don't have one? Register a new profile".

The Battlefords News-Optimist welcomes your opinions and comments. We do not allow personal attacks, offensive language or unsubstantiated allegations. We reserve the right to edit comments for length, style, legality and taste and reproduce them in print, electronic or otherwise. For further information, please contact the editor or publisher, or see our Terms and Conditions.

comments powered by Disqus