Four Strategies for The Risk-Averse Investor

Four Strategies for The Risk-Averse Investor

By Justin Carbonneau (@jjcarbonneau) —

Stocks are down.

Bonds are down.

Gold is down.

There’s no sugarcoating it — 2022 hasn’t been kind to investors.

The downturn in stocks and other assets reflect a number of concerning things. Inflation is the highest it’s been since the late 70s and early 80s, the Federal Reserve is raising interest rates and is on record saying it will do what it needs to in order to get inflation under control, even if it might mean driving the economy into a recession. Higher interest rates have made the affordability of homes and other assets much more costly. Add on to it geopolitical risks and de-globalization trends as a result of the war with Ukraine and Russia and uncertainty with China and Taiwan and there are a lot of potential problems out there.

All of this has impacted stocks, bonds and gold.

For companies, if profits start to be negatively impacted, that makes their values decline. Second, if investors aren’t willing to assign the same valuation to stocks (due to higher interest rates and uncertainty), that also has a negative effect. For bondholders, higher interest rates negatively impact current bond prices as investors shun lower yielding bonds and replace them with higher yielding issues. And gold, which is supposed to be an inflation hedge and safe haven, has been under pressure as investors have been offloading the yellow metal, putting pressure on prices, as this article summarizes.

But does this mean you should just bail on everything and give up?

I for one don’t think so and neither does Burton Malkiel, Princeton Economics professor and author of the classic finance book A Random Walk Down Wall Street. About a week ago Malkiel expressed his views that investors shouldn’t give up on stocks but they may consider a more conservative approach to how they go about selecting stocks.

That article, along with a few conservations on our recent podcasts got me thinking about some moves a long-term, risk conscious investor might consider today.

Consider Conservative Stocks

We recently interviewed Pim van Vliet on Excess returns, and while the episode is not out yet, I highly encourage investors to be on the lookout for it. We talk with Pim, who manages tens of billions of dollars using quantitative strategies, about low volatility and conservative stock investing. Buying large cap, less volatile stocks and seeking out companies that are paying dividends or buying back stock sits at the heart of van Vliet’s conservative stock selection approach. The long-term data supports this approach and when times get tough these stocks, which may be considered boring blue-chip names, have the tendency to hold up better. I wrote a more in-depth piece on the strategy, which is based on his book “High Returns from Low Risk: A Remarkable Stock Market Paradox”.

Savers Finally Have Options

The yield on the U.S. Treasury bond has gone from a low of 0.5% in the depths of the pandemic to close to 4% today. So, a bond investor today is getting 16x the yield someone got 2.5 years ago. Yes, inflation is running very hot so the real return on bonds isn’t as nearly as attractive, but if rates stay somewhat elevated and inflation starts to abate, bonds could start to be an attractive option for those looking for a decent return and the benefits of diversification.

And for investors who want less duration risk, even ultra-short bond funds are offering attractive options for investors. For instance, the Vanguard Ultra-Short bond ETF is yielding 3.5% – that’s an attractive yield on what is a low risk investment vehicle.

Consider Trend Carefully

In a recent post, financial pro and popular blogger, Joe Wiggins, wrote: “If we invest in equities but don’t understand that gut wrenching bear markets are the price of admission, we will sell at the most inopportune time.”

I couldn’t agree more with this but the reality is all investors are different. Try telling someone in retirement drawing off their investments for their expenses that the stock portion of the portfolio could decline 40%, 50% or even further in a bad bear market.

Many investors can’t emotionally deal with those types of losses.

While not for everyone, one way to help manage this is through the use of trend following. In its simplest form, trend following has you in the market when the trend is positive and out when the trend is negative (they are multitudes of trend following signals – here is Validea’s trend following tool).

There are positive and negatives with trend following that investors need to understand. On the plus side, an investor can be comforted by knowing there are rules to get them out of stocks when they are going down, and there is a disciplined approach to buying back in the market when the trend turns back positive. On the down side, trend following approaches have a tendency to get whipsawed, which can de-tract from returns if the signal gets it wrong, and they some trend following strategies aren’t very tax efficient in nature.

Multi-Asset Portfolios

Investors aren’t limited to only stocks or bonds either. There are a number of approaches, some you can find on Validea that incorporate lots of different assets — the All-Weather portfolio, Generalized Protective Momentum and Protective Asset Allocation utilize asset class exposure and diversification as well as momentum and trend following to help manage risk and generate reasonable returns for investors over time. We’ve spent considerable time looking for unique combinations of these portfolios in an attempt to find the mix that is best for our retired and risk-adverse clients. Given the 60-40 stock/bond portfolio is having one of its worst years on record we think strategies like these deserve some attention from investors seeking a balance of risk and return.  

Understanding There Are Tradeoffs

Investing is all about tradeoffs and each of the ideas above comes with a tradeoff and their own set of risks. It’s also a little disingenuous and easy for me to write about this now, after all these assets are down as much as they are. But my point is not to suggest that now is a good time to reduce risk. It is to give those investors who are lower on the risk spectrum some ideas to explore now or in the future as they seek conservative ways to manage their investments over time.

Justin J. Carbonneau is VP at Validea & Partner at Validea Capital Management.
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