Our Thoughts

A Reflection on Risk

The year is almost over, and make no mistake about it, 2017 was one of the hardest years for markets ever. Yes, you read that right. One of the hardest years.
Why am I saying that? Because one of the most important roles of every fiduciary managing money is simple: Manage Risk. If you can manage risk, returns will in time take care of themselves. Those who study markets know that what matters, over time, is not being up more than your benchmark. It’s actually being down less because of how severe losses impact longer term compounding.

It seems like any number of headlines this year, under ‘normal’ conditions, would have created severe volatility in stocks. Instead, for buy and hold investors this has been one of the most peaceful environments for equity returns in history. That doesn’t, however, mean that risk was eradicated. Risk is always present in markets. What is visible in a chart, however, is return, not the environment under which those returns were generated.

Have no doubt, volatility is going to make a comeback at some point. Markets, like everything in life, go through cycles. Peace is followed by war, and war followed by peace. The problem, of course, is knowing when and where that switch is flipped. Because one never knows the exact moment everything changes until long after it already has, one must manage risk continuously and at all times.

This is what has made 2017 one of the hardest markets ever to manage money in. Inherently, managing risk must mean having less return when risk is not manifesting itself. Risk reduction historically translates into return reduction. Any kind of return reduction in a year like this is borderline career ending for fiduciaries with clients who simply look at market averages, and make all comparisons against that regardless of whether or not it’s the right benchmark for their risk tolerances.

A comparison to an all-equity benchmark like the S&P 500 is wrong on its face; almost no one would want to, ask to, or be advised to, put all their investible assets into equities, let alone into a single style box! Such a comparison is particularly tricky to rail against since this current, nearly nine-year Bull Run began, so we don’t do that, doing so would dim the meaningfulness of risk management.

Mark Hulbert, writing at marketwatch.com, says “… it’s the rare investor who actually is able to stick with an all-stock portfolio during a Bear market. The far more typical pattern is for equity investors to throw in the towel as losses mount. Claude Erb, a former fixed-income and commodities manager at mutual fund firm TCW Group, puts it this way: “the people who can truly stomach the volatility of a 100% stock portfolio are either catatonic or dead.”

This has been a dangerous year to underperform in, and an extraordinarily difficult one in which to manage risk. One of the priorities we have had this year ( … and really, all along the way since March 10th, 2009) is finding the most-precise, most-compelling way to remind our clients that risk-management is critical to them and their ability to navigate a ‘survivable trip’ in the stock market, given that a bit of upside has to be exchanged in that pursuit.

Certain run-ups in the market that are missed are merely the ‘insurance premiums’ (risk-management maneuvers) one has to pay to hedge against disaster – we know that – but an aggrieved client may have a hard time beaming over the scholarly recitation of such a concept. As to the insurance premiums analogy, that’s still perfect: The only way to get a ‘return’ on your risk-management on your home – i.e., your homeowner’s insurance policy premiums – is to have the house robbed, or burned to the ground, or something equally hideous … otherwise, you’re technically ‘throwing your money away’ on that policy, right?

But none of us actually look at it that way of course … nor should we with regard to the stock market, risk management, and missed run-ups, either.


-Larry Adams, CPFA  (Midland, TX)