Understanding Real Market Risk

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At different times in market cycles I find that human behaviour changes. One area that seems to be have the widest fluctuation is in the area of risk. When we have a year like March 08 to March 09 everybody became so risk adverse it was tough both before and after the destruction. We had good markets going March 2008. Investors had not had a good downturn in a while and had forgotten the pain of taking on too much risk. They started to only look at the returns the TV and newspapers talked about on equity markets.

I do a lot of research, as well as having being through good and tough times; I knew we were going into tough times in the economy. I knew the markets would correct more than normal and I knew governments would lower rates to stimulate their economies. (I have to admit it was much, much worse than I ever imagined). When governments lower interest rates, bonds go up. (Click here for my blog - You Want Pain?)  New clients had a tough time following my advice to lower their equity exposure and increase their government bond exposure before the downturn. I started this process in late 2007. I’m sure these new clients felt I was wrong for a few months but ended up elated as I protected my clients. As you can imagine, these clients rebalanced with my recommendations without question after that.

Following the bottom in 2009, again it was excruciating to get any of my new clients, who came in at the bottom, into the proper balance for the recovery. Again, after time with me we ended up seeing eye to eye.

We have entered the next phase

We have entered the next phase in that we have had good markets for a while. I am finding prospective clients not understanding their current portfolio’s risk profile compared to their personal risk tolerance. They are simply looking at what had good returns last year and wanting that investment. No forward looking and no care about proper balance and risk control.

We always have corrections

Most will panic when we have a correction, and we always have corrections. My clients often kid me because I love a good correction as it brings reality back to investors and to markets. It also brings some good buying opportunities. Knowing how to properly balance a portfolio is tough to do. It is art, math and experience. Computer programs and head office driven advice do not protect the individual or meet their risk tolerance and their risk adjusted return. These will always underperform over time and are designed to protect the institution from future lawsuits (not maximize your return for your risk profile). At best you will do okay.

Potential ETF Risk

Another risk that is growing in popularity is Exchange Traded Funds (ETF), as investors believe they are not risky. Investors think they are buying a low cost mutual fund that follows an index. The vast majority are made up indices that do not follow what is known as an index in the industry. They have no idea that the ETF does not own the underlying securities as a mutual fund or segregated fund does. These are the same investors who would never want derivatives and/or futures in their portfolio. They do not understand this is in fact what they are investing in with ETFs. There is also a growing concern in the industry, and rightfully so, that investors think that since the ETF they are in is liquid (trades with good volume) they will have no liquidity problems. What they don’t know is whether the underlying securities are liquid and whether the other side of the future/derivatives’ contracts will remain liquid.

I was watching CNBC on March 31, 2015 and they stated that Stan Fischer was quoted on this topic. He is an economist and the Vice Chair of the U.S. Federal Reserve System and he is worried about this problem. ETF holders’ risk with some of these products could be huge.

The XIU ETF is lower than its peak in 2008

I was at a meeting the other morning and an investor told me he owns the XIU – the TSX 60 ETF – and he will just hold it. He has only made money on it and stated this ETF always has just gone up. He was shocked when I pointed out that it is currently lower than its peak in 2008 (7 years). Don’t get me wrong, I have and will continue to use ETFs for my clients but I extensively research the risk we are dealing with each ETF and match it to the correct client. Many could find that saving fees on the ETF’s costs will cost them a lot more, both in money and worry.

If you want to see what a truly independent investment/insurance advisor can do for you, call me at 905-846-9060, ext.3838, email me at Terry.McIntyre@manulifesecurities.ca or visit my website at www.terrymcintyre.ca