The problem with not having a dynamic approach is that what often results is something I call “asset allocation paralysis” where a portfolio manager in essence stays stuck with a clients asset allocation.  Though minor portfolio changes are made, the overall asset allocation stays rather “stuck” within very tight ranges and rebalancing is rarely implemented.

We do not think that portfolio managers should try to time markets.  That is for sure a fools game. What we do strongly believe, on the flipside, is that structural trends and forces take shape which are either bullish or bearish for asset prices. A systematic approach to measure what is the environment for each asset class will help to (1) remove  emotion from evaluating these markets and (2) aggregate multiple indicators into one consolidated measure for a specific market.

Asset allocation is one of the most important and difficult tasks a portfolio manager must choose for clients.  Over the long run, it is the most largest determinant of how much wealth a portfolio manager creates for clients.  By responding tactically and aggressively to market movements, portfolio managers can really add alpha.  Asset allocation paralysis is a cross between “buy and hope” and trend following, because whether you like it or not, your portfolios will trend with the markets.

Covert Analytics is a platform designed to help you avoid asset allocation paralysis! We initially conceptualized this platform to help investment advisors and portfolio managers have a systematic approach to fall back on when deciding on how to react to market movements.  Our clients use it blindly, because their asset allocation models are designed by them, built around their gut feelings, and produce clear and specific recommendations subject to their clients constraints.

Being a portfolio manager in the 80s and 90s was easy.  The chart below shows how well investors in stock and bond markets fared in the 80s and 90s.  Everyone knows what a disaster being a stock investor was in the late 60s and 70s.  That was the first secular bear market since the Great Depression.  In 1966 the Dow Jones was hovering around 1,000.  In 1982, it was still there, hovering around 1,000.  After adjusting for inflation, the results were even more disastrous.  The early 80s saw Time magazine quoting “The Death of Equities” and other similar headlines (great contrarian indicator in retrospect). This of course coincided with the start of one of the greatest bull markets of the 20th century, as equity markets bottomed in 1982 and staged one of the greatest rallies on record.   

From 1982 until 1999, US equity markets suffered only 1 negative year! And that is factoring in Black Monday – the one day market correction of over 20%!  The average annual return for US stock markets during this period (total return) was 18.6%. Even being conservatively positioned in bonds, investors saw great returns.  The Lehman Aggregate returned 9.5% average annual returns during the same period.  Like I said, being a portfolio manager in these years was easy.

The Good Times: Stocks (black) versus Bonds (amber) in the 80s and 90s

The current decade was another story.  Since January of 2000 (through November 2009), Equity investors are still underwater even factoring in dividends. The annualized return during this period is -1.5%, or a total loss of -14.3%. How have bonds fared? Far worse than the previous two decades, but still a respectable 6.5%.  This has been one of the most trying times in recent memory for any investor.  When looked at from a longer term perspective it is clear we entered another secular bear market some time in early 2000, and as history has shown, these can go on for many more years than investors are ready for.  And just when you are ready to throw in the towel, a new bull market is born.

The Bad Times: Stocks (black) versus Bonds (amber) since 2000

For the time being however, it is clear that Buy and Hold is a disastrous investment strategy in a secular bear market.  Investors will be rewarded for being dynamic, not static.  Keeping a global perspective on investment opportunities and not having a dogmatic approach both to asset allocation (the mix to stocks, bonds, commodities) will aid portfolio managers who need to generate alpha over the coming years.  Now is a time when portfolio managers will earn their salaries!