What is your strategy in a market downturn?

What is your strategy in a market downturn?

May, 2017

Mark Ritchie II

Most equity investors are told that the key to protection against the next large market decline is a diversified strategy or portfolio. Yet if this is true and so simple why do most managers using a broad diversification strategy regularly underperform the markets in total return, including return relative to risk?

We believe it is because equities are correlated the most (meaning moving in the same direction) during a decline; and they become more correlated in a severe decline. If this is the case, and as history has shown that over 80% of stocks follow the general market direction, it would seem to follow logically that diversification is potentially not the silver bullet its advertised to be.

There are many reasons investors are told to stay in the market even when conditions are adverse to doing so. We believe moving to cash however, to be the much better option in terms of both taking the sting out of a large decline and being cash ready when the storms clear.

Many advocates of the diversification camp will say that “timing the market is risky”, and although we would certainly agree at times, we also believe that holding your course into a potential hurricane is riskier. While many investment managers will claim you are paying them to provide proper diversification when the storm comes, we believe you are paying us to see the storm clouds before the torrent starts and to raise cash accordingly. Both strategies have their challenges, but when the inevitable storm turns ugly – raising your cash levels at the first signs of trouble will ensure that your exposure can potentially be small, while the diversification model ensures that you will be taking it on full force. Which strategy sounds riskier to you?