The holidays provided CCI a chance to catch up in some general
reading of the financial press. One item readers might find worthy of reading in its entirety is Bill Gross (of Pimco)
December Investment Insight letter. It can be found
here
Overall the article is consistent with his and Pimco's “new
normal” view of the world. More specifically, the article
provides an excellent description of why deleveraging, globalization,
technology, and demographics are macro level forces which could
likely mean global GDP may only be 2% for quite awhile. Consequently
he concludes that “Investors should expect future annualized bond
returns of 3–4% at best and equity returns only a few percentage
points higher. “ I agree with Mr. Gross's assessment of the future.
If that forecast is accurate, it has dire consequences for
investors, as it makes it increasingly unlikely that an individual
investor (or even professional investors like pension funds) will
ever be able to accumulate enough assets to fund a retirement.
The article then briefly discusses what
an investor might do to react to this environment. Specifically, it
lists some picks and pans for various asset classes. Generally
speaking, this seem like good, traditional, investment advice.
However, after very nicely articulating the rationale for a new
investment landscape, it is disappointing that these actionable ideas
are based only in the traditional components of asset allocation.
Perhaps that is not too surprising since Mr. Gross and Pimco are
primarily in the business of traditional portfolio management.
However, it seems logical that if there is a new macro level
environment reality, that investors should think about new ways to
generate returns.
Some vehicles and techniques that might
be considered by investors preparing for a new normal include:
Options – As Warren Buffet has
said, speculating in derivatives can be “financial weapons of
mass destruction”. Conversely, when used as hedges, options can
provide portfolio protection against draw downs and generate income.
This is especially true when selling options as opposed to buying
them. The volume of options traded in the markets has steadily
increased over the years. Someone is increasingly using this vehicle
to reconfigure their portfolios. An individual investor not using
options might be trying to compete without using all the tools
available to them. Hence, individual investors should be
determining how they want to utilize
options in this new
environment.
Margin/Leverage - Margin and
leverage is a double edged sword that can help or hurt returns.
Leverage can achieved be achieved via
options strategies. Also, with low borrowing costs, perhaps now is
one of the best times in history to consider carefully using small
amounts of margin as a way to strive to increase return without
increasing costs too much. Further with seemingly easier access to
portfolio margin accounts an individual investor may have new
opportunities to utilize these capabilities.
Market Neutral/Long-Short – Rule
number one for many investors is don't lose money. This rule has
always made sense because big draw downs in portfolios require even
a bigger upside moves to get back to even. If overall returns from
traditional portfolios are potentially muted in the future, it will
even be harder to recover from big losses. That makes rule number
one even more important, and that means investors may be well served
to place more emphasis on striving to achieve more stable
absolute returns. A portfolio configured to try to achieve more stable
absolute returns will likely need to deploy some market neutral,
long/short oriented strategies in their portfolio,
These techniques, like any other, are
not guaranteed to produce the results an investor desires. They also
bring with them their own set of risks. Investors deploying these
techniques for the first time will have to take the time to learn
these areas and find ways to mange the risks they bring. However,
the risks of these approaches need to be compared to the risk of
achieving traditional investment returns in the forecast of the
future that Mr. Grosses suggests. If that forecast is accurate,
there is not just a risk, but almost a guarantee, that just deploying
traditional portfolio management techniques will not provide
sufficient returns to meet long term goals. Hence it seems very risky
to be 100% committed to only traditional portfolio theory. If there
is a reasonable chance that Mr Gross's forecast is correct then it
seem like some reasonable portion of a portfolio should be allocated
to techniques that is designed to succeed in that type of
environment. Perhaps now is the time individual investors need to
learn how to invest in a new way for a new normal.
CCI plans to put
more focus on these techniques in 2013.
