With March Madness starting next week, it reminds us how coaches take a closer look at their playbooks this time of year in hopes of making it to the Big Dance. Offenses are shuffled, defenses are bolstered, and if the coach makes the right moves, the team walks away a winner.
Investors are at a similar crossroads these days. The eight-year bull market that started in 2009 has helped investor portfolios post remarkable growth—but it won’t last forever. Streaks are made to be broken and the NCAA tournament thrives on them. Almost every year a 12 seed upsets a 5 seed and there would be no March drama without upsets and a “Cinderella Story”.
It’s important then, for investors to re-examine their investment lineup and start preparing now for what will likely be a tougher game in the near future. For many, that means adopting a diversification strategy that goes beyond the standard 60/40 portfolio.
Since 2009, the equity side of investors’ portfolios—the offense—has done all of the work. From February 2009 through December 2016, investors benefited from annualized returns of 17.7% for the S&P 500—well above the average annual return for large cap stocks beginning in 1928. However, let’s not forget that equities bore the brunt of the losses during the financial crisis, experiencing a 51% loss based on monthly returns, so recent gains have only served to offset losses for many investors.
On the other side, fixed income assets—the defense—have provided investors with some downside protection but very little growth. Alternatives can provide two main benefits to client portfolios. With little-to-no correlation to traditional markets, certain alternatives can offer investors “true”diversification. True diversifiers can include Managed Futures, Global Macro, Market Neutral and Multicurrency funds. Additionally, other alternatives can offer downside protection without sacrificing return potential. Downside protectors include Non- Traditional Bond, Long/Short Equity and Long/Short Credit funds.
Limiting risks, not returns
In addition to adding true diversifiers to their portfolios, investors should also seek to add funds that reduce risk without overly sacrificing returns. On this front, most investment portfolios play it too safe resulting in lost opportunities for growth. Investors should look for funds that hold up during downturns and have the ability to outperform traditional downside protectors over longer periods.
As we move into a period of increasing economic uncertainty, it’s important to think like a coach heading into playoff season. Taking proactive steps to increase diversification and boost downside protection, without sacrificing returns, can help investors better manage gains and losses and emerge as winners over the long run.
Long/Short Equity can provide diversification beyond the standard 60/40 portfolio, read more in The New Core Allocation